This Note can usefully be read together with, and is a development of Franco Mastrandrea, "The Quantification of Termination Claims for Contractor Default" [2022] The International Construction Law Review 268.
NB Often, in the interests of speed, desire to contain likely further costs, or other reasons, replacement or continuation contracts may be let on a less risky (for the replacement contractor(s)) basis such as cost-plus or even on dayworks or "force account". Such arrangements may not only be markedly more expensive than those under which the original contract was let (such as lump sum arrangements), but also may be associated with significant inefficiencies in the continuation arrangements (it will very likely be suggested by those representing the original contractor that there is no incentive on the part of either the employer or (the) continuation contractor(s) to contain those costs). The aim should be for contract terms with the continuation contractor(s) to be specifically designed to limit inefficiencies. Thus, in resolving any dispute with the original contractor, the questions whether (the) replacement contract(s) should have been let on different terms, or should have been more appropriately managed or controlled, or were executed inefficiently, may become pertinent and potentially contentious considerations. Record investigations into, and decisions made on the appropriate replacement arrangements (and perceived justifications therefore).
- The common law compensatory damages principle (and usually express contract termination provisions in common use) seeks to place an innocent employer who has terminated an original contractor's employment for cause in the position that the employer would have been in had the original contractor, contrary to fact, performed the contract according to its terms. Where the original contractor's performance has been terminated for cause there will typically be a final reckoning/ statement of accounts between the original contractor and the employer. This (usually deferred until after the outstanding works have been completed), typically involves a comparison between the actual costs/losses incurred by the employer and what the employer would have paid had the original contractor taken the works to completion.
- The sum against which the legitimate actual costs are to be compared, on the credit side of the equation for the original contractor, is the total amount which would (otherwise) have been payable (on due completion by the original contractor) for the works in accordance with the contract, typically labelled a "notional account".
- Given that what will be involved will largely be costs-based
claims, there will need to be answers to (and the costs system will
need to be set up to meet the challenge of answering) the following
questions: see upcoming article – Franco Mastrandrea,
Localised delays – the poor relation in construction
claims appraisals?, 2023 ICLR 112:
a. Has the claimant (here the employer) incurred the sums that it claims?[1]
b. To what extent are the sums claimed attributable to the matters relied on by the claimant (here the
employer)?[2]
c. Are the costs claimed reasonable?[3]
- An essential feature of these costs is that they are properly recorded and are easily and comprehensively accessed.
- Are there any third party rights that might be exercised (such as funders' rights to step in)?
- Are there any rights that the employer may want to assign, such as the original contractor's contracts with third parties?
- Costs for securing possession of the site. Code for and record documents and costs of investigating, procurement, administering and close out.
- Costs for protecting the executed works against damage. Code for and record documents and costs investigating, procurement, administering and close out.
- Make the site, partly completed works, and materials, safe. Code for and record documents and costs of investigating, procurement, administering and close out.
- Consider whether performance or other bonds/securities provided in relation to the original contract should be called or invoked; administer their call, encashment and their proper accounting and close out. Code for and record documents and costs of investigating, administering and close out.
- Consider the costs of repatriation/disposal of the original contractor's resources having regard to the original contract terms. Code for and record documents and costs of investigating, administering and close out.
- Has the Employer to take out additional insurance of the works and materials? Code for and record documents and costs of investigating, procurement, administering and close out.
- Undertake a proper and more complete appraisal of work progress on site than would have been available through the standard contract administration/interim payment system: who, when, and at what cost? Code for and record documents and costs of investigating, procurement, administering and close out.
- .Arrange for the continuation of temporary support work and common user plant such as scaffolding. Code for and record documents and costs of investigating, procurement, administering and close out.
- Identify defective work, and provide for its removal and replacement. Code for and record documents and costs of investigating, procurement, administering and close out.
- .Identify and check the quality and availability of materials and goods on and off site which have become the property of the employer. Code for and record documents and costs of investigating, procurement, administering and close out.
- Identify and specify a scope of works for the continuation contractor(s) sufficient to act as a sound basis for the administration and close out of the remaining works, including the identification of long lead items. Code for and record documents and costs of investigating, procurement, administering and close out.
- Devise, draw up and administer tendering procedures/pricing documents for (a) replacement contractor(s) including the potential need to novate supply and subcontracts to the replacement contractor(s). Code for and record documents and costs for devising, drawing up and administering procurement, administering and close out.
- Canvass potential continuation or replacement contractors. Code, procure, administer and close out;
- New replacement contracts. Code for and record documents and costs of investigating, procurement, administering and close out. Identify variations and their costs; to the extent that these may have been variations under the original contract identify the extra over/reduced costs that are involved for the purposes of (a) notional account(s) (see 2 above). Ditto with claims arising under the replacement contracts (e.g. escalation, prolongation, disruption).
- Costs of consultants. Code for and record documents and costs of investigating, procurement, administering and close out. Identify variations and their costs; to the extent that these may have been variations under the original contract identify the extra over/reduced costs that are involved for the purposes of (a) notional account(s) (see 2 above). Ditto with claims arising under the replacement contracts (e.g. escalation, prolongation, disruption).
- Costs of in house personnel/facilities. Code for and record documents and costs of investigating, procurement, administering and close out. Identify variations and their costs; to the extent that these may have been variations under the original contract identify the extra over/reduced costs that are involved for the purposes of (a) notional account(s) (see 2 above). Ditto with claims arising under the replacement contracts (e.g. escalation, prolongation, disruption).
- Other in-house costs. Code for and record documents and costs of investigating, procurement, administering and close out. Identify variations and their costs; to the extent that these may have been variations under the original contract identify the extra over/reduced costs that are involved for the purposes of (a) notional account(s) (see 2 above). Ditto with claims arising under the replacement contracts (e.g. escalation, prolongation, disruption).
- Overheads. Define, code for and record documents and costs.
- Identify variations and their costs; to the extent that these may have been variations under the original contract identify the extra over/reduced costs that are involved for the purposes of (a) notional account(s) (see 2 above). Ditto with claims arising under the replacement contracts (e.g. escalation, prolongation, disruption).
- Delays: extant at date of termination, and in getting re-started; agreeing a viable completion programme and executing the completion works. Evaluate, determine actions and perceived justifications therefor and monitor and close out, recording all.
- Closing out all accounts, including settling claims. Note that it will be important to show that the costs are reasonable, which will include operating accounts in accordance with the relevant continuation contracts (see 3.c above ).
- Are there likely to issues over liquidated damages and if so, is there an easy split between those accrued at the date of termination, which will require an appraisal on delay caused as at that date, and post-termination LADs? Evaluate, determine actions and perceived justifications therefor and monitor and close out, recording all.
Footnotes
1 Providing an adequate answer to this question involves
enquiries of matters such as: whether the sums claimed are
traceable to and through the various stages of the employer's
cost and accounting system; the extent to which the employer has
paid its contractor(s) the sums(s) that it claims; whether the sums
claimed include estimates, forecasts, adjustments (such as for
on-costs, consumables, etc.) and if so, the extent to which they
are appropriate and reasonable; and the extent to which account has
been taken of credits, transfers, discounts, rebates,
accommodations, contra-charges etc. which affect the value of the
sums claimed.
The verification of costs incurred requires appropriate access to
documents which identify the total costs of the project including
management accounts, statutory accounts, and the job costing
system, the method of cost allocation, and the definitions of cost
and the cost codes used sufficient to allow objective checking of
costs claimed through that system from the lowliest source
documents to the apex organisation accounts and to track the
allocation and costs of all resources into it from relevant records
– including the rationale for and decisions made on
procurement strategy; invitations to tender; tenders; reason for
decisions to appoint; orders/contracts; invoices; payment
vouchers/certificates, payments (including bank statements, etc.)
ledgers; final accounts; time sheets, wage sheets, payroll, fringe
benefits, other on-costs; establishment charges; information about
the commercial arrangements for the supply of plant and equipment,
including purchase amounts, ages, writing down policy, rental
agreements; copies of claims/counterclaims/contra charges made by
or against the employer which may have a bearing on the value of
the claims made; correspondence/dealings/final accounts and records
of payments to and from organisations whose financial claims are
pursued by the employer or who have made claims against the
employer which alternatively explain the financial claims;
documents evidencing any relevant settlements and payments made
which explain the parties' contentions and the settlements
reached and why; audited accounts demonstrating actual overheads,
and details (if any) of alternatives alleged to have been lost; in
respect of interest/financing charges details of costs incurred or
opportunities lost as a result of the complaints relied upon;
details and records of currency exchange losses alleged to have
been incurred.
The difficulty with an approach which falls short of this is that
because it is not open book, it may be incomplete and may as a
result be misleading.
2 An adequate answer to this question is likely to
involve the following more detailed enquiries (and documents should
record): whether the sums claimed have been correctly allocated to
the project and to the default relied on; the nature of the sums
claimed such as one-off, time-sensitive, volume-related etc.;
enquiries into the reasons and events which it is alleged gave rise
to the sums claimed; whether the sums claimed would have been
incurred in any event, and if so whether loss of alternatives
foregone have been shown; what other reasons or events may explain
incurrence of the amounts claimed.
Forming a view as to whether the sums claimed are properly
attributable to the matters relied on may involve consideration of
relevant tender build-ups where the claims for actual or additional
cost rely on the adequacy of counterpart allowances in that tender;
for personnel their disciplines, grades, tasks, time records,
allocation, and quantities of work carried out; for plant and/or
equipment: time and allocation records showing down time, the cost
of repairs and maintenance, and quantities of work carried out;
correspondence/dealings/final accounts and records of payments to
and from organisations whose financial claims are pursued by the
employer or who have made claims against the employer which
alternatively explain the financial claims; internal reconciliation
statements or reports which address or have a bearing on those
claims; copies of claims/counterclaims/contra charges which address
or have a bearing on those claims.
These questions should generate a process of enquiry which includes
the location and ordering of relevant information, and the
checking, processing, and analysis of that information.
It would in the ordinary course be incumbent upon the employer not
only for reasons of sound and robust contractual administration
internally but also to satisfy objective requirements of the
satisfactory proof and substantiation of claims, that it have in
place a system which not only located with sufficient certainty the
true additional costs generated by the issues about which complaint
is made, but also tracked those costs appropriately and
comprehensively as its response to the alleged difficulties were
implemented.
Thus, a properly designed response should ensure that relevant
tasks and costs which were truly additional to the original
contractual obligations were identified, managed and audited. This
should be capable of identifying and separating out matters
attributable to other causes, such as poor original estimating, and
the poor performance (by either the employer or any of its
contractors) of either those original contractual obligations or of
the newly commissioned obligations. Contracts routinely let on a
labour supply basis rather than on a task or results related
arrangement, increase the need for careful control to ensure that
the deployment and use of resources was efficient. It would be
expected in those circumstances to see a full description of the
processes introduced by the employer and/or its relevant contractor
to ensure that the resources were necessary, appropriate for the
work in hand, and deployed efficiently. In this context a related
consideration is the terms upon which such contracts are let, or
varied..
3 Whether costs incurred are reasonable involves a number
of more detailed enquiries, such as whether the procurement process
was appropriate for the works procured having regard to the
circumstances prevailing when it was carried out; whether contract
terms entered into were reasonable having regard to the sums
claimed, the terms of any head contract and the circumstances
prevailing when any associated sub-contracts were made, varied or
settled; whether the amount claimed has been properly and
reasonably incurred having particular regard to the avoidance of
waste, adequacy of supervision, control, etc.; whether expenditure
which could reasonably have been avoided has been paid; whether
there is any duplication; whether the employer has calculated and
paid the sums that it claims in accordance with the appropriate
terms of the sub-contract or supply contract.
Whether costs incurred are reasonable involves a number of more
detailed enquiries, such as whether the procurement process was
appropriate for the works procured having regard to the
circumstances prevailing when it was carried out; whether contract
terms entered into were reasonable having regard to the sums
claimed, the terms of any head contract and the circumstances
prevailing when any associated sub-contracts were made, varied or
settled; whether the amount claimed has been properly and
reasonably incurred having particular regard to the avoidance of
waste, adequacy of supervision, control, etc.; whether expenditure
which could reasonably have been avoided has been paid; whether
there is any duplication; whether the employer has calculated and
paid the sums that it claims in accordance with the appropriate
terms of the sub-contract or supply contract.
Part of the relevant context for the analysis involves a
consideration of the responses of the employer to those claims at
the relevant time, and in particular its appraisal of the situation
at that time, being a relevant feature in determining whether the
costs incurred in consequence were reasonable.
At the organisational level useful indicators of this would be
management accounts and internal reconciliation statements.
At the project level what is relevant is how the re-procurement
process was used and in particular whether it was used
appropriately, involving a consideration of the tendering
procedures and appraisals, and contracting methods used by the
employer. Clearly the prevailing circumstances may introduce the
need for greater urgency than would apply to a project which was
unfolding in broadly the expected manner, and thus render of
marginally less concern the pursuit of procurement strategies which
achieve greatest cost certainty. It will assist if this is
articulated and recorded.
But precisely because in such circumstances costs are likely to
escalate unreasonably, the employer is best advised to pursue a
robust, well-structured, and effective policy to promote economy in
not only the original re-commissioning of that work, but also in
its variation from time to time and its commercial settlement. Thus
even if work was procured on a time and materials basis, and it was
appropriately so procured, the employer should nevertheless pursue
(and articulate and record the actions directed at) the objective
of delivering the now impacted project:
(a) As economically as possible;
(b) By not engaging greater resources than were in the
circumstances reasonably required; and
(c) By reference to a proper definition of what items are
recoverable and the financial basis upon which that recovery is
based.
Something which did not satisfy these criteria would run the risk
of being little more than open-ended obligations. Managing the
process so as to keep within reasonable paparameters after
procurement is another key concern.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.