How Valuable is the FIDIC Suite for Construction of Project Financed

© 2006 Doug Jones AM. These materials are subject to copyright. No part may be reproduced, adapted or communicated without

written consent of the copyright owner except as permitted under applicable copyright law.

Society of Construction Law (Singapore)

International Conference, Singapore

16 October 2006

How Valuable is the FIDIC Suite for Construction of Project Financed Projects?

Professor Doug Jones AM, RFD, BA, LLM, FCIArb, FIAMA

Clayton Utz, Lawyers, No. 1 O'Connell Street, Sydney, Australia

tel +61 (0) 2 9353 4120 fax +61 (0) 2 8220 6700 email [email protected]

London Chambers: Atkin Chambers, 1 Atkin Building, Gray's Inn, London, WC1R 5AT, United Kingdom

Tel: +44 (0) 20 7404 0102 Fax: +44 (0) 20 7405 7456 Email: [email protected]

© 2006 Doug Jones AM. These materials are subject to copyright. No part may be reproduced, adapted or communicated

without written consent of the copyright owner except as permitted under applicable copyright law. 1

How Valuable is the FIDIC Suite for Construction of Project Financed

Projects?1

Professor Doug Jones

AM RFD, BA, LLM, FCIArb, FIAMA

Partner, Clayton Utz

1. Introduction

Project financiers have three primary concerns when considering whether or not to finance a

major project: cost, timely completion, and revenue. To achieve certainty and reduce risk in

these three critical areas, financiers and their advisors must pay particular attention to the terms

of the construction contract between the project vehicle and the contractor. As the financier is

not a party to this contract, its requirements and interests must be channelled and protected via

the project vehicle that it funds.

This paper will explore whether the financier's requirements and interests are appropriately

addressed and protected by the FIDIC suite of contracts, with particular focus on the operation

of the FIDIC EPC/Turnkey Projects Contract - the "Silver Book". The Silver Book was

specifically created and released in 1999 by FIDIC in response to industry demand for a

standard form contract applicable to project financed projects. Although the Silver Book is

more favourable to the project vehicle (and consequently the financier2) than the contractor, as

will be discussed in this paper, it still falls short of guaranteeing financiers the certainty and

risk protection that they require. These shortcomings are highlighted by the fact that, in

practice, the Silver Book is usually the subject of significant amendments by parties or

disregarded altogether, thereby rendering the FIDIC suite of lesser value to project financed

projects than its drafters presumably intended.

1.1 The nature of project finance

Project finance is a form of finance often used in infrastructure projects. There are many

different structures that may be employed in projects using this method of finance, limited only

by the imagination of the financiers and other parties to the transaction. However, a common

factor distinguishes project finance from other forms of financing, which is that the financiers

1 The author gratefully acknowledges the assistance provided in the preparation of this paper by Julia Hoffmann,

Senior Solicitor, and Catherine Mann, Paralegal, Clayton Utz.

2 The terms "financier" and "lender" are used interchangeably throughout this paper.



rely on the revenues generated by the project itself for the repayment of the debt and there is

limited recourse to the sponsors of the project, if any. For this reason, project finance may

often be referred to as "non-recourse" financing.

The non-recourse basis of project financing places numerous risks on the financiers of such

projects. The financiers will generally only have recourse to the cash-flows generated by the

project when completed and the assets subsisting in the project. In many cases, the value of

those assets will be significantly less than the total obligations of the borrower - the project

sponsor. In this context, two factors are of paramount importance. First, the financiers to a

project financed on a non-recourse basis must be certain that the cash-flows forecast to be

obtained from the completed project will be sufficient to service the debt. Second, financiers

must be confident that the project assets will be completed and become operational, and thus

are able to generate the revenues from which the borrower's debt service obligations will be

discharged.

As a consequence, financiers usually require the construction contract to have a fixed price and

date of completion, with recourse to the contractor in the event of failure. This increased

certainty, however, comes at a premium in terms of a higher contract price to reflect the

contractor's greater assumption of risk.

1.2 Classic structure for project financing

The variety of financing structures is almost coextensive with the number of projects that

proceed on a project finance footing. Numerous approaches may each have advantages

depending on the composition of the sponsors and lenders, the regulatory framework in which

the project is implemented, and the type of project. The potential for variation means that it is

not possible to provide a comprehensive analysis of the different structures in this paper.

However, in the context of discussing construction risks, the following generalised structure

will be assumed:

• The sponsors form a project vehicle, which is then used to implement the project.

The project vehicle is either an entity separate from the sponsors, or it remains

linked to the sponsors but a detailed regime is put in place to protect the assets of

the sponsors from the liabilities of the project vehicle;

• Financiers lend to the project vehicle pursuant to conditions contained in a loan

agreement, typically limiting recourse to the assets of the project vehicle and the

revenues from the project assets;

• The project vehicle engages contractors to construct the project assets;



• The project vehicle receives revenue from the assets and services the debt from

those revenues; and

• Any profits made by the project vehicle are eventually distributed to the sponsors.

Below is an example of a classic structure of a project financed project. The key players for

the purposes of this paper will be the financiers, the project vehicle (the "employer" in FIDIC

contracts) and the contractor.

As this diagram demonstrates, the construction contract is only one in a number of agreements

in the project, although it is one of the most complex because of the competing interests of the

contractor, project vehicle and lenders. There is an important interplay between the

construction contract and these other agreements, particularly:

• the concession agreement between the project vehicle and the government if the

project is BOT-style;

• the loan agreement; and

• the off-take contract, which establishes the basic terms by which the product will

produce revenue, for example, through road tolls or sale of power.

Operator

Supplier of project

resources

e.g. power

Contractor

Product off-

taker

Government

Financiers

Project vehicle

Loan

agreement

Concession agreement

Construction contract

Operating

agreement

Supply agreement

Off-take agreement



Lenders have an interest in all these agreements, and significant interactions between the

construction contract and the other project documents are highlighted in this paper.

1.3 Risk allocation and project delivery methods

The method of project delivery has a fundamental bearing upon the risks arising during, and

subsequent to, the construction of infrastructure. Different delivery structures have widely

differing implications in terms of the risks borne by each of the parties and therefore financiers

need to be cognisant of the risk allocation implicit in particular methods of project delivery.

Financiers have a real interest in the choice of project delivery structure and need to

understand the options available as, generally speaking, the risks borne by the financier in this

context are those borne by the project vehicle or owner.

A table outlining delivery models with advantages and disadvantages for the financier is

included in Appendix 1. The EPC/turnkey model will be the particular focus of this paper as it

is the model found in the FIDIC Silver Book and is the most commonly used delivery model in

a project finance context. Its attractions to project financiers are the lump-sum pricing and

single-point completion responsibility, which provide greater completion certainty - reducing

the risk to financiers, who would otherwise rely only on the project assets to recover their loan.

1.4 Risk allocation in drafting the contract

While the choice of delivery method sets the scene for the allocation of risk between the

parties, the terms of the contract itself will be the ultimate determinant of the rights and

obligations of the parties. For this reason, it is necessary for the parties to ensure that the terms

of the contract impose rights and obligations that complement the risk allocation desired by the

parties and are appropriate to the delivery structure. A clear allocation of risk is vital. In

particular, due to the complexity of these projects and the variety of causes of each risks, risk

allocation should be linked to causation according to which party can best control the causal

event.3 Financiers ought to be concerned with the terms of the construction contract, with a

view to controlling their exposure to risk. The diligent financier should ensure that the risk

allocation contained in the contractual provisions reflects the basis upon which they are willing

to provide finance, and is not watered down by the contract. In addition, financiers should

make certain that their interests will be protected. Although to an extent the project vehicle

represents the financier in the construction contract, the financier should be involved in the

3 JG Mauel, "Common Contractual Risk Allocations in International Power Projects" (1996) Columbia Business

Law Review 37 at 41.



contract, both at the drafting stage and in contract administration, in order to safeguard their

interests.

Also important is that in BOT projects the contractor is usually a shareholder of the project

company and a member of the sponsoring organisation, so it should be able to make its views

heard at the negotiation and drafting stage.4

2. Background to the Silver Book

In 1999 FIDIC published a suite of four new Standard Forms of Contract:

• Conditions of Contract for Construction for Building and Engineering Works

Designed by the Employer (known as the "Red Book");

• Conditions of Contract for Plant and Design-Build for Electrical and Mechanical

Plant, and for Building and Engineering Works, Designed by the Contractor (known

as the "Yellow Book");

• Conditions of Contract for EPC/Turnkey Projects (known as the "Silver Book") -

NEW;

• Short form of Contract, a new form designed for minor works (known as the "Green

Book") - NEW;

The Conditions of Contract for Design-Build and Turnkey (known as the "Orange Book", and

first issued in 1995) was not updated.

The impetus for this was the need to update the Red and Yellow Books to reflect changes in

the construction industry and the increased numbers of larger and more complex projects. The

increased use of project financing motivated the addition of the Silver Book to the suite.

According to the Introductory Note to the Silver Book, FIDIC perceived that the construction

market, in the context of project finance, required a contract where employers were willing to

pay more for certainty of price and completion date. Its application, however, is not limited to

project financing. The Introductory Note states that it is intended to be suitable "for all the

many projects, both large and smaller, particularly E & M (Electrical and Mechanical) and

other process plant projects, being carried out around the world by all types of employers,

often in a civil law environment, where the government departments or private developers

4 C Wade, "The Silver Book - The Reality" (2001) 18(3) International Construction Law Review 497 at 509.



wish to implement their project on a fixed-price turnkey basis and with a strictly two party

approach".5 The Silver Book, unusually for a FIDIC contract, has no engineer.

According to its Introductory Note, the Silver Book will have to be modified in the context of

project financing in order to take account of lenders' requirements. Additionally, in the

Introductory Note, FIDIC recommends a number of circumstances in which the Silver Book is

inappropriate and the Yellow Book should be used:

• If there is insufficient time or information for tenderers to scrutinise and check the

Employer's Requirements or for them to carry out their designs, risk assessment

studies and estimations;

• If there will be substantial work underground or work in other areas which tenderers

cannot inspect;

• If the employer intends to supervise closely or control the contractor's work, or to

review most of the construction drawings; or

• If the amount of each interim payment is to be determined by an official or other

intermediary.

As the contract intended to be used in project financed projects, the Silver Book will be the

focus of analysis in this paper. Given that FIDIC recommends falling back on the Yellow

Book as an alternative to the Silver Book, the paper will also note where the Yellow Book

differs from the Silver Book.

2.1 The rationale for the Silver Book

The Silver Book represents a departure from FIDIC's traditional principles of balanced risk

sharing by primarily allocating risk to the contractor. At the time of the publication of the

Silver Book, FIDIC argued it was responding to demand from the construction market for a

form that suits turnkey projects - including, but not limited to, project financed projects -

where the employer is willing to pay a higher price for increased certainty of completion date

and final cost. Placing an increased burden of risk on the contractor is necessary for such a

project.6

5 Introductory Note to First Edition of Silver Book.

6 C Wade, "FIDIC's Standard Forms of Contract - Principles and Scope of the Four New Books" (2000) 17(1)

International Construction Law Review 5 at 11.



In light of this market demand, FIDIC decided to develop a standard form contract tailored to

such projects, rather than leaving employers to "mutilate" the other FIDIC contracts to suit

their needs, a practice which disadvantaged contractors and led to poorly drafted contracts.7

Instead, the open and clear allocation of risk and responsibility in the Silver Book was

intended to benefit all parties. Christopher Wade, who as Chairman of FIDIC's committee for

International Contract Conditions was responsible for production of the new suite, stated that

"FIDIC (bearing in mind its position as exponent and even in some respects guardian of the

best modern engineering practice), came - rightly or wrongly - to the conclusion that one has to

move with the times, and that it is often better to face up to the market demands, rather than

deny their obvious existence... one cannot halt progress."8 FIDIC also argued that in BOT

projects there is substantial negotiation before signing the contract, and in this context the

Silver Book is intended to be a starting point, or a "guide at the outset", rather than a finished

product.9

The allocation of greater risk to the contractor meant that the publication of the Silver Book

was met, unsurprisingly, with severe criticism from contractors and others. These will be

identified throughout this paper. While not all the criticisms are justified, financiers need to be

aware of these arguments if there is to be a considered allocation of risk and a successful

project. Parties should also note that a number of clauses were amended to be more favourable

to the contractor,10

and the financier should therefore consider whether these provisions reflect

the risk allocation on which basis they have agreed to finance the project.

2.2 Layout of the Silver Book

The Silver Book comprises:

• General Conditions, consisting of 20 clauses which are themselves divided into sub-

clauses that form the provisions of the contract. The sub-clauses are those which

FIDIC considered would be applicable to many contracts, proceeding on the basis

that parties would prefer to delete or modify inapplicable provisions rather than

draft additional text for the Particular Conditions;11

7 C Wade, above n 4, at 502.



10 Sub-Clauses 2.4, 2.5, 13.7, 14.8, 16.1, 17.4, 19.1, 20.1.

11 Foreword to the Silver Book.



• Particular Conditions, containing modifications and additions to the General

Conditions. These Particular Conditions are referred to in many sub-clauses in the

General Conditions. Some sub-clauses in the General Conditions do not operate

unless required to by the Particular Conditions, for example, advance payments12

and performance security.13

FIDIC has contemplated that the Silver Book will be substantially adapted to the parties'

situation, and so has published with the Silver Book a "Guidance for the Preparation of

Particular Conditions" which suggests text options for the Particular Conditions. It is

necessary to remember that the Silver Book is a standard form contract which should be

modified by parties to reflect their needs. They are thus free to amend the terms to achieve the

risk allocation appropriate for their project.

3. Project finance requirements and the Silver Book

This section will evaluate the Silver Book from the financier's perspective. Examining the

main areas of risk for the financier (cost, time and quality) as well as other risks of concern,

this section will set out the relevant clauses of the Silver Book and assess them according to

project finance requirements.

3.1 Cost risks

For obvious reasons, a key concern for financiers will be the provisions of the contract which

affect the cost of the project, as unbudgeted cost overruns will threaten the viability of the

project vehicle and may lead to the financier being required to advance more funds than those

initially approved, in order for the project to be completed.

The pricing structure for the works has the most significant influence on the allocation of cost

risk, as the magnitude of risks borne by the financier will vary significantly depending on

whether the contract has, for example, a lump-sum or a cost plus fee pricing structure. The

Silver Book is project finance-friendly, and provides for a fixed lump sum price. Using this

payment method places the onus on the contractor to correctly price the project and bear the

risk of currency fluctuation and changes to the cost of materials and labour, giving the

financiers certainty of price.

12 Sub-Clause 14.2.

13 Sub-Clause 4.2.



"Contract Price" is defined in the Silver Book as "the agreed amount stated in the Contract

Agreement for the design, execution and completion of the Works and the remedying of any

defects, and includes adjustments (if any) in accordance with the Contract". Further, sub-

clause 4.11 provides that "the Contractor shall be deemed to have satisfied himself as to the

correctness and sufficiency of the Contract Price."

Set out in the table below are the circumstances that give rise to the "adjustments" referred to

in the definition of "Contract Price", as well as extensions of time:14

Sub-

Clause

Heading Sub-Clause content - circumstances entitling adjustment EOT?

Yes/No

Cost?

Yes/No

Profit?

Yes/No

2.1 Right of

Access

If the contractor is not given access to the site as required

under this clause. (Note that access may be denied if the

contractor has not yet provided the performance security.)

yes yes yes

4.24 Fossils Complying with the employer's instructions in relation to any

fossils found on-site

yes yes no

7.4 Testing Contractor is instructed to vary the location or details of

specified tests or carry out additional tests

yes yes yes

8.9 Consequences

of suspension

Contractor is instructed by employer under Sub-Clause 8.8 to

suspend part or all of the works.

yes yes no

9.2 Delayed tests Tests on Completion unduly delayed by the employer yes yes yes

10.3 Interference

with Tests on

Completion

Contractor is prevented for more than 14 days from carrying

out Tests on Completion by a cause for which the employer

is responsible

yes yes yes

11.8 Contractor to

search for the

cause of any

defect

Contractor is instructed to search for a cause of a defect, and

the cause of the defect not the fault of contractor.

no yes

yes

12.2 Delayed tests Unreasonable delay by the employer to the Tests after

Completion

no yes

yes

14 Adjustment by variation is also possible - see section 3.4(a) below.



Sub-

Clause


Yes/No

Cost?

Yes/No

Profit?

Yes/No

12.4 Failure to pass

Tests after

Completion

Unreasonable delay by the employer in permitting access to

the works or plant, either to investigate the causes of a failure

to pass a Test after Completion or to carry out any

adjustments or modifications

no yes

yes

13.7 Adjustment

for changes in

legislation

Contract price shall be adjusted to taken account of any

increase or decrease in cost resulting from a change in the

laws of the country, which affect the contractor in the

performance of its obligations.

yes yes no

13.8 Adjustments

for changes in

costs

If the contract price is to be adjusted for rises or falls in the

cost of labour, goods and other inputs to the works, the

adjustments are to be calculated in accordance with the

provisions in the Particular Conditions.

n/a yes no

14.8 Delayed

payment

If the contractor does not receive payment in accordance with

sub-clause 14.7 (Timing of Payments), the contractor will be

entitled to receive financing charges compounded monthly on

the amount unpaid during the period of delay.

The clause provides the rate of interest.

n/a n/a. n/a

16.1 Contractor's

entitlement to

suspend work

If the employer fails to comply with sub-clause 2.4 (financial

arrangements) and sub-clause 4.7 (timing of payment) the

contractor may suspend work. The contractor must give 21

days notice of its intention to do so.

yes yes yes

17.4 Consequences

of employer's

risks15

Rectification of loss or damages to the works, goods or

Contractor's Documents caused by employer's risks

yes yes no

19.4 Consequences

of force

If the contractor is prevented from performing any of its

obligations under the contract and suffers delay or incurs cost

yes yes for

certain

no

15 " Employer's Risks" are defined in Sub-Clause 17.3 as "(a) war, hostilities, invasion, act of foreign enemies, (b)

rebellion, terrorism, revolution, insurrection, military or usurped power, or civil war, within the Country, (c) riot,

commotion or disorder within the Country by persons other than the Contractor's Personnel and other employees of

the Contractor and Subcontractors, (d) munitions of war, explosive materials ,ionising radiation or contamination by

radio-activity, within the Country, except as may be attributable to the Contractor's use of such munitions

explosives, radiation or radio-activity, and (e) pressure waves caused by aircraft or other aerial devices travelling at

sonic or supersonic speeds."



Sub-

Clause


Yes/No

Cost?

Yes/No

Profit?

Yes/No

majeure16 by reason of a force majeure types of

force

majeure

Financiers may wish to limit the scope for adjustment of the contract price, by deleting or

amending the above provisions, or capping the amount of adjustment. In particular, it would

be prudent from the financier and employer's perspective to remove the possibility of

adjustment for rises or falls in the costs of labour, goods and other inputs to the works under

Sub-Clause 13.8. Note that the Yellow Book as well as allowing this adjustment provides

formulae for its calculation.17

(a) Payment

The actual mechanics of payment of the contract price are also relevant to financiers. The

Silver Book has a complex payment structure of advance payment, interim payment, and final

payment, which is explored below.

(i) Advance payment

The Silver Book allows advance payment to be made for design and mobilisation.18

The

advance payment is an interest-free loan. It is up to the parties to agree upon the amount of the

advance payment in the Particular Conditions. If no amount is agreed, then the sub-clause is

inapplicable - there is no advance payment. If an amount is provided, but the terms of

16 "Force Majeure" is defined in Sub-Clause 19.1 as "an exceptional event or circumstance: (a) which is beyond a Party's control, (b) which such Party could not reasonably have provided against before entering into the Contract,

(c) which, having arisen, such Party could not reasonably have avoided or overcome, and (d) which is not

substantially attributable to the other Party."

"Force majeure may include but is not limited to, exceptional events or circumstances of the kind listed below, so

long as conditions (a) to (d) above are satisfied: (i) war, hostilities (whether war be declared or not), invasion, act of

foreign enemies, (ii) rebellion, terrorism, revolution, insurrection, military or usurped power, or civil war, (iii) riot,

commotion, disorder, strike or lockout by persons other than the Contractor's Personnel and other employees of the

Contractor and Sub-contractors, (iv) munitions of war, explosive materials, ionising radiation or contamination by

radio-activity, except as may be attributable to the Contractor's use of such munitions, explosives, radiation or radio-

activity, and (v) natural catastrophes such as earthquake, hurricane, typhoon or volcanic activity."

17 Sub-Clause 13.8.

18 Sub-Clause 14.2.



payment are not otherwise stipulated, then default provisions determine the basis and timing of

payment.19

These default provisions require the advance payment to be made once the contractor has

provided:

• an application for interim payments;20

• the performance security in accordance with Sub-Clause 4.2; and

• a guarantee (subject to certain conditions) in amounts and currencies equal to the

advance payment.

The provision of a guarantee should allay most financiers concerns as to the appropriateness of

advance payment.

The employer is required to pay the first instalment of the advance payment within 42 days of

the date on which the contract came into full force and effect or within 21 days of the

employer receiving the performance security and claim for advance payment.21

It has been

suggested that it may in fact be in all parties' interests, from a cash flow perspective for the

contractor, and from the perspective of the financier and employer in getting the project

underway, that the advance payment be made at the commencement of the contract - however,

obviously for the financier it would be critical, in the context of security, that the performance

security and guarantee were, in any event, in place.

The advance payment is repaid in proportional deductions to interim payments, which are

discussed below.

(ii) Interim payment

The Silver Book sets out an interim payment procedure at Sub-Clause 14.3. The procedure

itself is reasonably conventional in requiring the contractor to submit a statement of the

amount claimed and any additions/reductions and retention figures, together with supporting

documentation of its claim. The timing of the submission of the statement, if not stated, is

after the end of each month.

19 Sub-Clause 14.2.

20 Sub-Clause 14.3.

21 Sub-Clause 14.7.



The interim payment procedure gives the contractor incentive for early completion. The

contract may include a schedule of payments as to the instalments in which the contract price

will be paid.22

Unless otherwise agreed by the parties, Sub-Clause 14.4 also provides the basis

of the calculation of the instalments, and the procedure to be followed in the event that there is

no schedule of payments. The procedure could be improved for the financier, however, by

requiring the employer to prepare the schedule of payments based on completion of discrete

tasks, which must be completed to the satisfaction of the employer's representative (that is,

following testing).23

Then the completion of such construction tasks could be independently

verified before allowing payment.24

This would not only provide an incentive for early

completion but also ensure the construction produces a fit for purpose project asset.

The employer may be entitled to withhold payment:25

• if the employer has not received and approved the performance security;

• if anything supplied or work done by the contractor is not in accordance with the

contract, the cost of rectification or replacement may be withheld until rectification

or replacement has been completed;

• if the contractor was or is failing to perform any work or obligation in accordance

with the contract, and has been so notified by the employer, in which case the value

of this work or obligation may be withheld until the work or obligation has been

performed.

Further, the Silver Book provides that the employer may, by any payment, set-off "any

correction or modification that should properly be made".26

These exceptions to payment

provide the employer with considerable discretion, which should therefore appeal to

financiers. In addition, the requirement for the contractor to provide security before receiving

interim payment for plant and materials27

should make the payment acceptable to financiers.

22 Sub-Clause 14.4.

23 JA Huse, Understanding and Negotiating Turnkey and EPC Contracts, 2nd ed, London, Sweet & Maxwell, 2002,

at 645.

24 JA Huse, above n 23, at 645.

25 Sub-Clause 14.6.

26 Sub-Clause 14.6.

27 Sub-Clause 14.5.



In terms of timing of payment, the Silver Book provides that payment is to be made within 56

days of receiving the statement and supporting documentation.28

This is a considerably longer

period than under most contracts. However, if payment is late, the contractor is entitled to

financing charges compounded monthly on the unpaid amount.29

Further, if the basis of the

calculation has not been provided in the Particular Conditions, then the Silver Book provides

by default that these charges are to be calculated at the annual rate of three percentage points

above the discount rate of the central bank in the country of the currency of payment, and shall

be paid in such currency.30

This default method of calculation is reasonably generous to

contractors.

(iii) Final payment

The Silver Book provides a staged process for final payment.

The contractor is first required to submit a statement at completion within 84 days of the

contractor receiving the taking-over certificate for the works.31

The statement at completion is

similar in content to the statements for interim payment, and requires supporting

documentation, as well as details of the value of all work done up to the date stated in the

taking-over certificate and an estimate of any other amounts which the contractor considers

will become due to him under the contract. The notice provisions for the employer and the

timing of payment are the same as those for interim payment (that is, 28 days notice of any

objections, and payment within 56 days of the employer's receipt of the statement).

Once the employer has issued the performance certificate in accordance with Sub-Clause 11.9,

to confirm the date on which the contractor completed its obligations under the contract, the

contractor must, within 56 days of receiving the performance certificate, submit a draft final

statement with supporting documentation showing the value of all work done in accordance

with the contract and any further sums which the contractor considers to be due to him under

the contract or otherwise. The employer may require additional supporting material and

agreed changes may be made to the draft before it is submitted in final form. The final

statement is to be accompanied by a written discharge which confirms that the total of the final

statement represents full and final settlement of all moneys due to the contractor under or in

28 Sub-Clause 14.7(b).

29 Sub-Clause 14.8.

30 Sub-Clause 14.8.

31 Sub-Clause 14.10.



connection with the contract.32

If there is a dispute as to the final amount due, the employer is

required to pay whatever amounts are agreed, and the dispute will be submitted to the dispute

resolution process set out in Clause 20 of the contract. The final statement will then be issued

after the dispute has been resolved.

The Silver Book expressly limits the employer's liability to the claims made in the final

statement and statement at completion, as it provides that the employer shall not be liable to

the contractor for any matter or thing under or in connection with the contract or execution of

the works that is not included therein.33

(iv) Financier involvement in payment?

The Silver Book, as a two-party contract, does not provide for any financier involvement in

payment. An alternative to the model presented in the Silver Book would be for the financiers

to be responsible for payments. Under such a system, the contractor makes regular claims for

progress payments under the contract. These claims are then submitted to the financier, and if

they are satisfied that any preconditions to payment have been met they may release the

payment. The strength of such an approach is that the financier should be able to satisfy itself

as to the work that has been done by requiring their information needs to be met before

payment occurs. It is also possible to attach other conditions to payment, such as requiring

that payment claims be capped at an amount specified in a pre-agreed drawdown schedule.

Financiers should consider whether they wish to gain greater control of the payment process

through taking over responsibility from the employer, or alternatively by requiring the

employer to consult with the financier prior to making any decisions on payment.

(b) Cost risks under the Silver Book: conclusion

The Silver Book goes some way towards addressing project finance requirements for minimal

cost risk. The lump sum pricing, guarantee for advance payment and the employer's discretion

regarding interim payments provide a cost and payment structure generally favourable to

financiers.

There are deficiencies, however, and it would be prudent for financiers to insist upon some

amendments to the circumstances in which the contract price may be adjusted, as well as to

aspects of payment mechanisms such as linking interim payments to completion of discrete

tasks. The financiers may also wish to have greater involvement in the payment process.





3.2 Time risks

Time is of major concern to the financier because a delay to completion usually results in a

delay to the revenue stream. This in turn may detrimentally affect the solvency or profitability

of the project. Given that time is so critical in projects which are undertaken on a project

finance basis, the construction contract often allocates risk for all delays to the contractor, as

does the Silver Book, on the basis that the contractor's control of design and construction

means it is most able to avoid late completion. Accordingly, the Silver Books sets out a

limited range of grounds for an extension of time for completion, and imposes delay damages

on the contractor as penalty for lateness where no extension of time has been granted.

Unlike some other contracts, however, the Silver Book does not provide for a bonus for early

completion. Such a bonus can be a useful way of lessening time risks as it provides the

contractor with an incentive to promptly complete the works, and given the importance of on-

time completion to financiers, could be a wise addition to the construction contract.

Financiers should also note that in the Silver Book the contractor is entitled to the benefit of

the early completion float. Sub-Clause 8.4 refers to entitlement to an extension of time if

"completion for the purposes of Sub-Clause 10.1 (Taking Over of the Works and Sections) is

or will be delayed" rather than if the deadline of the time for completion will not be met.

Similarly, Sub-Clause 8.2 obliges the contractor to complete the works "within the Time for

Completion".

This probably makes more sense as where the contractor carries out the work, particularly in a

design-build context, it is best able to schedule and plan for work.34

In these circumstances, if

a contractor has been able to progress ahead of time, it is entitled to the benefit of the float

achieved. However, financiers may wish instead for the employer to have the benefit of the

float so as to reduce completion risk.

(a) Extensions of time

As extensions of time necessarily delay the financier's recovery of the loan, these provisions

are of considerable importance to the financier, who will be keen to ensure that only a limited

range of circumstances give rise to an entitlement to an extension of time.

The Silver Book list of events entitling the contractor to an extension of time is exhaustive,

reflecting the importance of on-time completion in project financed projects. Sub-Clause 8.4

34 JK Hoyle, "The Rainbow Down Under - Part 2: Further Reflections from the Antipodes on Aspects of the New

FIDIC Design-Build Contracts" (2002) 19(1) International Construction Law Review 4 at 11.



provides generally the circumstances in which the contractor is entitled to an extension of

time:

• variations;

• delays, impediments or prevention caused or attributable to the employer, their

personnel or their other contractors; and

• other entitlements set out in the contract.

Grounds for an extension of time found elsewhere in the contract concern circumstances in

which completion is or will be delayed as a result of:

• the employer's failure to give the contractor access to or possession of all or parts of

the site within the time stated in the Particular Conditions;35

• the contractor complying with the employer's instructions to the contractor

regarding items of archaeological or geological interest found on the site;36

• the contractor complying with the employer's instructions to vary the location or

details of specified tests, or carry out additional tests, or a delay for which the

employer is responsible;37

• the contractor diligently following procedures of the public authorities, and the

authorities delay or disrupt the contractor's work, if the delay or disruption was not

reasonably foreseeable at the date of tender;38

• the contractor complying with the employer's instructions to suspend or resume

work;39

• Tests on Completion being unduly delayed by the employer;40

35 Sub-Clause 2.1.

36 Sub-Clause 4.24.

37 Sub-Clause 7.4.

38 Sub-Clause 8.5.

39 Sub-Clause 8.9.

40 Sub-Clause 9.2.



• the contractor being prevented for more than 14 days from carrying out the Tests on

Completion by a cause for which the employer is responsible;41

• changes in the laws or in the judicial or official interpretation of such laws of the

host country;42

• the contractor's suspension of work for non-payment by the employer, or the

employer's failure to provide evidence of his ability to pay;43

• an employer's risk;44

• a force majeure event.45

Financiers should be relatively content with these grounds. The Silver Book has substantially

fewer grounds for extensions of time than the other FIDIC forms, and their scope is

comparable with what financiers are accustomed to accepting in practice.46

Financiers should

also be satisfied that failure to comply with the procedure for contractor's claims outlined in

Sub-Clause 20.1 will defeat the claim for an extension of time.

Nonetheless, if financiers are tempted to reduce the list of events entitling an extension of time,

they should note that the choice of events is essentially a commercial decision. If the

occurrence of a class of event does not entitle an extension of time, a risk inevitably falls on

the contractor, which risk will ultimately be priced into the bid of the contractor, increasing the

cost of delivering the project. If the risk of the event occurring lies within the control of the

employer, the risk premium it attracts may be exorbitant. For this reason, failure to award an

extension of time for preventive acts may have adverse consequences. It may be

uneconomical for the contractor to have no entitlement to an extension of time in the event of a

variation initiated by the employer. Alternatively, it may be more productive for the employer

to be able to order acceleration (as under Sub-Clause 8.6), so that the employer retains some

control over the attendant increase in cost, rather than the contractor pricing the risk into the

41 Sub-Clause 10.3.

42 Sub-Clause 13.7.

43 Sub-Clause 16.1.

44 Sub-Clause 17.4. "Employer's risk" is defined at n 15.

45 Sub-Clause 19.4. "Force majeure" is defined at n 16.

46 B de Cazalet and R Reece, "The New FIDIC EPC BOT Contract" (1999) 180 Project Finance International 50 at

52.



contract price. The capacity of the employer to control the progress of the works in this way is

discussed below.47

In addition to these considerations, it is clear that the financier has an interest in ensuring the

extensions of time clause is carefully drafted to avoid the possibility of a preventive act setting

time at large, so that the contractor no longer has the obligation to complete by the specified

date. Otherwise, if the employer causes a delay and the contractor fails to follow a notice

procedure or does not claim an extension of time, the employer will be unable to claim

liquidated damages from the contractor for failure to complete on time.48

This means that

where the employer commits a preventive act, the contractor can avoid paying liquidated

damages by not claiming for an extension of time. Contracts often seek to avoid the operation

of the prevention principle by permitting the employer or the employer's representative to

unilaterally grant an extension of time, a power which is not granted in the Silver Book.

Financiers would be advised to press for the inclusion of such a provision in order to ensure

that the employer stays solvent through liquidated damages in the event of late completion.

The extension of time sub-clause could also be improved for the employer by specifying that

an extension of time will only be granted where there is delay to the critical path and the

contractor could not have avoided or reduced it.49

This would help to minimise the risk of late

completion by reducing the potential for unnecessary extensions of time.

Financiers may also want the concession contract to transfer to the host government the risks

of contractor's claims for extensions of time arising out of events within the control of the host

government. These may include force majeure events within the control of the host

government and delay caused by failure of the authorities to issue permits.50

As discussed

below, consistency between the various contracts is important to managing risk across the

project as a whole.

(b) Calculation of delay damages

A delay in completion will have adverse financial consequences for the employer and hence

the financier. The loss suffered by the employer for delayed completion may be recovered as

damages for breach of contract. However, as is common in construction contracts, the Silver

47 See section 3.2(c).

48 JK Hoyle, above n 34, at 11-12.





Book allows the employer to recover liquidated damages (or delay damages, as they are known

in the FIDIC contracts) as a debt due under the contract when completion occurs after the date

set down for completion. This has numerous advantages from a practical perspective, as actual

loss need not be proven,51

and the contractor's liability may be capped at a manageable level in

the Particular Conditions. Delay damages also provide an incentive for the contractor to

complete on time and maintain the project company's solvency in case of late completion.

The level at which delay damages are set in the Particular Conditions is an important part of

risk allocation in major projects. In large infrastructure projects, the losses that may flow as a

result of a contractor's late completion may be enormous. In some cases, the potential loss

may be so great that no contractor would willingly participate in the project without the benefit

of some limitation of their potential liability. The calculation of the per-day rate of liquidated

damages is where many decisions about the amount of risk to be retained by the employer

manifest themselves, so the financier should be involved in this decision.

The Silver Book requires that if the contractor fails to comply with the time for completion it

shall pay delay damages for every day until the date stated in the taking-over certificate, for the

sum stated in the Particular Conditions.52

Importantly, delay damages are no substitute for

performance: the contractor must still complete the works and comply with any other

obligations under the contract. There are, however, some limitations to liability for delay

damages for failure to complete within time. The only other delay damages for which the

contractor may be liable are those connected to termination by the employer for cause under

Sub-Clause 15.2.53

Sub-Clause 17.6 also limits liability to the amount of the contract price and

prohibits liability for loss of use of any works, loss of profit, loss of any contract or for any

indirect or consequential loss or damage which may be suffered other than under Sub-Clause

16.4 (payment on termination) and Sub-Clause 17.1 (indemnities). The Particular Conditions

may also set a maximum amount of delay damages.

The employer may wish to have the level of delay damages fixed by reference to the financing

costs incurred during the period of delay so that it passes through to the contractor its liability

for interest payments to the financier consequent on late loan repayment.

Parties should also be aware that the interpretation of delay damages clauses will be affected

significantly by the applicable law, as they are not recognised in all legal systems, or may be

51 Subject to the applicable law: see below n 57.

52 Sub-Clause 8.7.

53 Discussed below at section 3.4(e)(ii).



reduced if a court finds them to be excessive.54

For example, delay damages under English

law are only awarded commensurate with actual loss; in contrast with civil law, they cannot be

in the nature of a penalty.55

The per diem basis of delay damages under the Silver Book

should be proof of their compensatory nature but may not be sufficient.56

Additionally, in

some common law jurisdictions liquidated damages are not recoverable without proof of actual

loss.57

Nonetheless, these provisions go some way towards keeping the project vehicle solvent in the

event of late completion and thus ensuring the financier's loan is repaid, however, given their

significance, financiers would be wise to be involved in negotiation of the amount of delay

damages and any maximum set.

(c) Project management

Reflecting the importance of on-time completion in project finance, the Silver Book contains

provisions by which the employer can control the project in order to minimise the risk of late

completion.

The contractor is required to submit a programme within 28 days of commencement and revise

it whenever the employer gives notice, within 21 days, that the programme does not comply

with the contract or actual progress of the work, or if the contractor gives notice to the

employer of specific probable future events or circumstances which may adversely affect or

delay construction.58

The content requirements of a valid programme are set out in more detail

than in previous editions of the FIDIC contracts, including order and timing of the works,

periods for review under Sub-Clause 5.2, sequence and timing of inspections and tests, and a

supporting report which includes a general description of the methods the contractor intends to

adopt and the approximate number of the contractor's personnel and equipment for each major

54 JA Huse, above n 23, at 275, 292. See also A Kus, J Markus and R Steding, "FIDIC's New 'Silver Book' Under

the German Standard Form Contracts Act" (1999) 16(4) International Construction Law Review 533 at 543.

55 NDJ Henchie, "FIDIC Conditions of Contract for EPC Turnkey Projects - The Silver Book: Problems in Store?"

(2001) 18(1) International Construction Law Review 41 at 54.


57 In Malaysia, s 75 of the Contracts Act 1950, has been interpreted to require actual proof of damages incurred

unless the amount set in the contract was a true or genuine pre-estimate of the loss (Wearne Brothers (M) Ltd v

Jackson [1966] 2 MLJ 155; Selva Kumar a/l Murugiah v Thiagarajah a/l Retnasamy [1955] 1 MLJ 817). In India, s

74 of the Contract Act 1872 also requires the plaintiff to prove actual loss (Bhai Panna Singh v Bhai Arjun Singh

AIR (1929) PC 179). See G Xavier, "Global Harmonisation of Contract Laws - Fact, or Fiction" (2004) 20(1)

Construction Law Journal 3 at 17.

58 Sub-Clause 8.3.



stage. This provision should be drafted to be consistent with any obligation to keep the

financiers informed through progress updates and regular reports.59

In addition, the employer may require the contractor to submit a revised programme and report

on revised methods showing how the contractor plans to expedite progress and complete

within the time for completion.60

This may be ordered if actual progress is too slow to

complete within that time and/or progress has fallen or will fall behind the current programme,

unless the contractor is entitled to an extension of time. The revised methods may include

increased working hours, or amount of goods or number of personnel, and the contractor must

bear the costs, as well as any additional costs incurred by the employer and any delay

damages. These provisions are important ways in which the employer can monitor the project

and be able to respond at an early stage to circumstances that could prevent on-time

completion. Given their utility, financiers may wish to have a more official and active role in

this process.

Suspension provisions are also a powerful method of enabling the employer to control the

progress of the project, although as suspension may prevent the project from being completed

on time, financiers would be wise to insist that it will not be ordered without their approval.

As it stands, the Silver Book permits the employer to order the suspension of progress on all or

part of the works at any time for any reason.61

The contractor must secure the works from loss,

deterioration and damage, and upon resumption of the work the contractor must make good

any deterioration or defect in or loss of the works, plant or materials which has occurred during

the suspension, regardless of the cause of the suspension.62

Financiers and employers should also note that the contractor may be able to claim an

extension of time or actual costs if pursuant to suspension or resumption of the work the

contractor suffers delay and/or incurs cost.63

However, the contractor may not be compensated

for lost profit, and neither an extension of time nor costs are available if the cause of the

suspension is the contractor's responsibility. The contractor must notify the employer and


60 Sub-Clause 8.6.

61 Sub-Clause 8.8.

62 Sub-Clause 8.12.

63 Sub-Clause 8.9.



comply with the procedure for contractors' claims set out in Sub-Clause 20.1, which, as

discussed below,64

is generally favourable to the employer.

Additionally, if the contractor is not responsible for the suspension, it is entitled to payment of

the values of plant and/or materials which have not been delivered to the site if the work on

plant or delivery of plant or materials has been suspended for more than 28 days and the

contractor has marked the plant or materials as the employer's property in accordance with the

employer's instructions.65

Financiers should also note that there are detrimental consequences of suspension lasting more

than 84 days, if the cause of the suspension is not the contractor's responsibility. If the

contractor requests the employer's permission to proceed, and the employer does not give

permission within 28 days of the request, the contractor may give notice to the employer that it

is treating it as an omission under Clause 13 (governing variations and adjustments) of the

affected part of the works.66

Further, if the suspension affects the whole of the works, the

contractor may give notice of termination under Sub-Clause 16.2.

As this demonstrates, while suspension provisions give the employer greater control over the

project, they are an example of circumstances in which the employer's interests and the

financiers' interests may not be completely aligned. For this reason, to minimise the risk of

delay to revenue from the project, financiers should ensure they are strongly involved in the

use of suspension powers.

(d) Time risks under the Silver Book: conclusion

The Silver Book is generally successful, from the project financier's perspective, in allocating

time risks to the contractor. However, it is important that financiers are involved in

administration of the provisions which allow for employer control of time risk, in particular

where the employer's and financiers' interests diverge. In addition, the extension of time

provisions could give the employer/financier greater control in relation to preventive acts and

unilateral extensions of time. A bonus for early completion would also be favourable to

financiers.

64 See section 3.4(b).

65 Sub-Clause 8.10.

66 Sub-Clause 8.11.



3.3 Quality risks

The quality of the project is crucial to the project vehicle, and as a result, the financier. The

quality of the completed project will determine its ability to fulfil its intended purpose, as well

as having more obvious consequences such as increased repair and maintenance costs. Failure

to fulfil the intended purpose will also jeopardise compliance with the other agreements

involved in a project financed project. Importantly for the financiers, repayment of the loan

depends on the capacity to obtain revenue from a working asset; a project that is deficient may

reduce revenue. Quality risks in the Silver Book encompass design obligations, the fitness for

purpose standard, responsibility for site data and unforeseeable conditions, the employer's

capacity to monitor quality during constructions, and aspects of completion.

(a) Design obligations

Under the Silver Book the contractor assumes responsibility for the design of the works.67

Additionally, the contractor is deemed to have scrutinised the Employer's Requirements,68

prior to the base date, and is responsible for the design of the works and for the accuracy of the

Employer's Requirements. The employer is not responsible for the accuracy of the Employer's

Requirements and is deemed not to have given any representation as to their accuracy. The

only aspects for which the employer retains responsibility are:

• portions, data and information which are stated in the contract as being immutable

or the responsibility of the employer;

• definitions of intended purposes of the works or any parts thereof;

• criteria for the testing and performance of the completed works; and

• portions, data and information which cannot be verified by the contractor, except as

otherwise stated in the contract.69

This last exception in particular has the potential to be a fertile source of disputes and

contractors' claims. It is problematic because it does not specify the relevant time at which the

information must be unable to be verified by the contractor. Edward Corbett has suggested

that the argument that would be most convincing to arbitrators would be that it refers to

67 Sub-Clause 5.1.

68 The Employer's Requirements are the documents specifying the purpose, scope, design and technical criteria for

the works (Sub-Clause 1.1.1.3).

69 Sub-Clause 5.1.



verification at tender stage.70

It would, however, be in financiers' interests to limit this

exception. This sub-clause also displaces the fitness for purpose standard in respect of these

exceptions. A more certain allocation of responsibility by removing the exceptions may be

preferable to financiers (for a higher price of course). In addition, in the Australian context it

would seem that contractors can argue that an employer's intervention in design demonstrates a

lack of reliance on the contractor's design, precluding contractor liability for design defects.71

This appears to thwart the intention of the Silver Book.

Due to this allocation of responsibility, the Introductory Note advises that the Silver Book is

inappropriate for projects in which the employer wishes to review most of the construction

drawings.

If this risk allocation is nevertheless unacceptable to the contractor and the financier/employer

is willing to negotiate, then the Yellow Book allocates less risk to the contractor and may be an

alternative. In the Yellow Book, while the contractor must still carry out and be responsible

for the design of the works, the contractor has a period in which to scrutinise the Employer's

Requirements and give notice of any error or other defect found therein. The engineer then

determines whether there should be a variation or adjustment. If, taking account of cost and

time, an experienced contractor exercising due care would not have discovered the error or

other defect when examining the site and the Employer's Requirements before submitting the

tender, then the time for completion and the contract price may be adjusted. This test - the

experienced contractor exercising due care - has been criticised for its indeterminacy.72

The

Yellow Book also differs from the Silver Book in the inclusion of employer's design as an

employer's risk.73

However, to compensate for this, the Yellow Book has a quality assurance

scheme: the Yellow Book requires that design be undertaken by qualified designers who

comply with any criteria stated in the Employer's Requirements. In addition, the engineer

must approve each proposed designer and design subcontractor.74

The contractor also warrants

70 E Corbett, "FIDIC's New Rainbow 1st Edition - An Advance?" (2000) 17(2) International Construction Law

Review 253 at 269.

71 Cable (1956) Limited v Hucherson Bros Pty Limited (1969) 123 CLR 143, discussed in JK Hoyle, "The Rainbow

Down Under - Part 1: Some Reflections from the Antipodes on Aspects of the New FIDIC Design-Build Contracts"

(2001) 18(1) International Construction Law Review 5 at 19.

72 E Corbett, above n 70, at 268.

73 Sub-Clause 17.3(g).

74 Sub-Clause 5.1.



that the contractor, the designers, and the design subcontractors have the experience and

capability necessary for the design.75

In both the Silver Book and Yellow Book the contractor remains responsible for ensuring that

the design, Contractor's Documents,76

execution and the completed works will be in

accordance with the law of the country, and the documents forming the contract, that is,

including the Employer's Requirements.77

The contractor is also responsible for compliance

with local technical standards, building, construction and environmental laws, laws applicable

to the product being produced and any other standards specified in the Employer's

Requirements.78

If these change after the base date the contractor must give notice to the

employer and submit proposals for compliance, if appropriate; the employer shall initiate a

variation if it determines that compliance is required and that the proposals for compliance

constitute a variation. Financiers may also wish the contract to expressly state that the

contractor is still obliged to design and construct the works in accordance with the fitness for

purpose obligation, regardless of reliance on those technical standards.79

Notably for financiers, responsibility for the Contractor's Documents remains with the

contractor notwithstanding any approval or consent by the employer: if errors, omissions,

ambiguities, inconsistencies, inadequacies or other defects are found in the Contractor's

Documents, they and the works must be corrected at the contractor's cost.80

The Silver Book and Yellow Book allow different scope for employer supervision of the

design process. In the Silver Book, if the Employer's Requirements so provide, the employer

may review the Contractor's Documents, and unless the parties otherwise agree, execution may

not commence until the expiry of the review period, which shall not exceed 21 days.81

This

review does not relieve the contractor of responsibility. However, the employer's power is

limited to advising that the Contractor's Documents fail to comply with the contract, in which

case the contractor must rectify and resubmit them for review. In contrast, the review

75 Sub-Clause 5.1.

76 "Contractor's Documents" are defined in Sub-Clause 1.1.6.1 as "the calculations, computer programs and other

software, drawings, annuals, models and other documents of a technical nature supplied by the Contractor under the

Contract".

77 Sub-Clause 5.3.

78 Sub-Clause 5.4.

79 JA Huse, above n 23, at 226-227.

80 Sub-Clause 5.8.

81 Sub-Clause 5.2.



procedure in the Yellow Book permits the Employer's Requirements to specify that the

Contractor's Documents be reviewed and/or approved before work commences, although such

review and/or approval does not relieve the contractor of any responsibility or obligation.82

Huse suggests the provision for review only in the Silver Book is to ensure the employer does

not bear any responsibility for design,83

but surely the disclaimer at the end of the Sub-Clause

that the contractor remains responsible is sufficient for this purpose. Financiers may prefer the

Yellow Book model if they wish the employer to have greater supervision of the design

process.

The potential for the significant control by the employer in using this position is unusual for

turnkey contracts, and contractors argue that they should be free to achieve the performance

criteria in the manner of their own choosing. A response is that non-compliance with the

contract in terms of performance criteria will be unlikely to be established at the design stage.84

The issue of employer intervention will be explored in greater detail below.85

(b) Fitness for purpose

Consistent with the nature of an EPC/Turnkey project, under the Silver Book the contractor

undertakes to design and construct works that are fit for their purpose and to remedy any

defects.86

The fitness for purpose standard imposed in the Silver Book has been criticised as

placing a heavy burden on contractors due to its interaction with a number of other provisions

in the contract. Firstly, although the contractor is liable for design, the employer can require

review of design, as discussed above.87

Secondly, the contractor is liable even where the

Employer's Requirements are insufficient for the purpose of the works.88

Contractors also make a number of general criticisms of the fitness for purpose standard.

Contractors take on extra risks where they employ design consultants, as consultants can only

obtain insurance up to a standard of reasonable skill and care. The contractor will therefore

bear the cost of work that is less than fit for purpose but where more than reasonable skill and

82 Sub-Clause 5.2.



85 See section 3.4(d)(i).

86 Sub-Clause 4.1.

87 Sub-Clause 5.2.

88 Sub-Clause 5.1.



care was used. Related, the contractor is held to a higher standard of care than a professional

designer would be, although the employer's response will be that a higher standard is necessary

to ensure the contractor does not cut costs and supply an inferior design. Lastly, the contractor

will be liable even where the standards and knowledge of the industry are such that no

competent contractor would have noticed the flaw in the design.89

However, fitness for purpose is essential for financiers given that revenue from the project is

their only recourse to the loan. Financiers will be unwilling to lend where there is no

guarantee that there will be a working, revenue-producing asset. Nonetheless, if particular

standards are required in order to produce the necessary revenue, it would be in financiers'

interests to ensure they are also specified in the contract.

(c) Site data and unforeseeable conditions

The Silver Book allocates to the contractor all responsibility for verifying and interpreting the

site data provided by the employer.90

Under this sub-clause, the employer has no liability for

the accuracy, sufficiency or completeness of site data, except for data that the contract states is

immutable or the responsibility of the employer, and data which cannot be verified by the

contractor. Financiers may therefore wish that in order to maximise risk allocation to the

contractor, the employer provide no site data, or allow the contractor plenty of time to verify

the data and require the contractor to expressly state it had full opportunity and did verify all

data provided by the employer.91

In contrast, in the Yellow Book the employer undertakes the

investigation and the contractor is only responsible for interpreting, not verifying, the data.92

Additionally, in the Yellow Book the contractor is only deemed to have obtained all necessary

information to "the extent which was practicable (taking account of cost and time)".93

Gaede

argues this makes more sense than multiple tenderers all having to investigate, duplicating

tests and costs.94

However, financiers may not be happy with the significant potential for the

contractor to argue that it was too costly or there was insufficient time to obtain the necessary

information.

89 JA Huse, above n 23, at 149-150.

90 Sub-Clause 4.10.


92 Sub-Clause 5.1.

93 Sub-Clause 4.10.



Except as otherwise stated in the contract, the contractor also bears all risk of unforeseeable

ground conditions.95

Under this Sub-Clause, the contractor is deemed to have obtained all

necessary information regarding risks, contingencies and other circumstances which may

influence or affect the works. The contractor accepts total responsibility for having foreseen

all difficulties and costs of successfully completing the works and the contract price is not

adjusted to take account of any unforseen difficulties or costs.

Where the contractor assumes the risk of unforeseeable ground conditions, the contract price

should increase to reflect this. However, in practice, contractors may find such risk to be

difficult to quantify, due to its unforeseeable nature, which could lead to higher pricing.96

Huse suggests that it may be more economical for employers to assume the risk themselves

and pay a lower contract price.97

As discussed below, this will be influenced by the market

and the parties' bargaining power.98

The Yellow Book provisions on unforeseeable conditions are more favourable to contractors.

Under the Yellow Book the contractor may be entitled to an extension of time or additional

costs if it encounters unforeseeable adverse physical conditions.99

Unforeseeable means "not

reasonably foreseeable by an experienced contractor by the date for submission of the

Tender".100

In determining the claim, the engineer may reduce those additional costs if there

were physical conditions in similar parts of the works which were more favourable than could

reasonably have been foreseen when the tender was submitted.101

However, the application of

a foreseeability standard has been criticised, for example, because the real test is not whether

something was foreseeable but whether there should have been allowance for it.102

94 AH Gaede Jr, "The Silver Book: An Unfortunate Shift from FIDIC's Tradition of Being Evenhanded and of

Focusing on the Best Interests of the Project" (2000) 17(4) International Construction Law Review 477 at 488. See

also JA Huse, above n 23, at 52.

95 Sub-Clause 4.12.



98 See section 5 below.

99 Sub-Clause 4.12.

100 Sub-Clause 1.1.6.8.


102 See for example, E Corbett, above n 70, at 258.



There is some justification for the risk allocation in the Silver Book. The contractor is

arguably the most qualified person to bear the risk, given it will have conducted site

investigations and is in charge of design and construction.103

In a project financing context,

FIDIC reasons, lenders will be willing for the contractor to include the risk of unforeseen

ground conditions in the contract price. The Introductory Note advises that the risk allocation

should be accompanied by willingness to allow the tenderer time to verify all relevant

information and data and make any necessary investigations. Additionally, the Introductory

Note recommends that the Silver Book should not be used where there will be insufficient time

for this aspect, or where construction will involve substantial work underground or work in

areas where tenderers cannot inspect. FIDIC also argues that the risk of unforeseen ground

conditions will be negligible in the majority of projects for which the Silver Book will be used,

and will be of less significance than other risks turnkey contractors assume.104

A number of

commentators, however, have observed that since most infrastructure projects involve

substantial underground work, the Silver Book thus excludes most of the projects for which it

intends to cater.105

Contractors may be able to mitigate the risk if they negotiate for the

employer to pass on any relief it obtains from the host government for this,106

although

financiers may prefer the employer to keep the benefit and be in the best position possible. It

would be advisable that where there will be substantial work underground and an increased

chance of encountering unforeseen ground conditions, that the parties include a specific risk

allocation.107

The provisions concerning site data and unforeseen ground conditions are some of the most

severely criticised in the Silver Book; contractors in particular argue that they place an

unreasonable burden of risk on contractors. While not all these criticisms are maintainable,

financiers and employers need to be aware of this general perception of the Silver Book and be

prepared for these arguments at the stage of contract negotiation.

One criticism advanced is that these provisions will lead to the contract being awarded to the

tenderer with the lowest bid who has included in the price little or no contingency for

103 B de Cazalet and R Reece, above n 46, at 51.


105 AH Gaede Jr, "Letter to the editor: FIDIC Conditions" (2001) 18(4) International Construction Law Review 703

at 709; NDJ Henchie, above n 55, at 46.





unforeseen ground conditions, and who may be the least qualified.108

Tenderers may be

reluctant to price the risk and jeopardise being awarded the contract. In addition, the fact that

the contractor has performed site investigation is arguably irrelevant to the issue of who should

bear the risk, which by definition is unforeseen.109

It is also argued that financiers and

employers will not be able to distinguish, as the Introductory Note does, between projects

where ground conditions are known or certain and projects where ground conditions are

unknown or uncertain and for which the Silver Book is therefore inappropriate.110

Henchie has argued that in relation to site data, the standard of what is able to be verified by

the contractor is so imprecise as to lead to disputes.111

A number of commentators also suggest

that the contractor will try to recover costs from the employer if unforeseen ground conditions

are encountered, and that there are various arguments they can make based on other terms in

the contract, for instance, that contractors are not responsible for the correctness of the

employer's data which cannot be verified.112

The contractor might also argue that

unforeseeable ground conditions are a force majeure event.113

Unforeseeable ground

conditions could also be characterised as frustration: an event or circumstance outside the

control of the parties making it impossible to fulfil contractual obligations, thus releasing the

parties from performance.114

This risk allocation, they argue, is therefore likely to cause

disputes, and is thus counter-productive.115

As Huse notes, however, as this allocation of risk increasingly reflects industry practice in

relation to international EPC contracts, criticisms should be directed at the practice rather than

the Silver Book.116

108 AH Gaede Jr, "The Silver Book: An Unfortunate Shift from FIDIC's Tradition of Being Evenhanded and of

Focusing on the Best Interests of the Project" (2000) 17(4) International Construction Law Review 477 at 485; JA

Huse, above n 23, at 52-53.

109 See AH Gaede Jr, above n 108, at 485.

110 See AH Gaede Jr, above n 108, at 488.

111 NDJ Henchie, above n 55, at 45.

112 Sub-Clause 5.1(d).



115 AH Gaede Jr, above n 108, at 489-490; NDJ Henchie, above n 55, at 46.




(d) Monitoring quality during construction

Tests and standards are necessary for the employer and the financier to be satisfied that the

construction is of the quality desired, particularly where contractors may be endeavouring to

cut costs to meet a low contract price. However, an unnecessary level of testing should not be

permitted to jeopardise cost and time certainty. The Silver Book contains a number of

provisions which permit the employer to oversee construction and be sure it is getting the

quality for which it contracted.

The Silver Book requires the contractor to carry out the manufacture of plant, the production

and manufacture of materials, and all other execution of the works in the manner specified in

the contract, in a proper workmanlike and careful manner in accordance with recognised good

practice and with properly equipped and non-hazardous materials, except as otherwise

specified in the contract.117

Huse suggests that to resolve the ambiguity in the standard of

"good practice", parties specify a relevant professional standard.118

The Silver Book provides for a quality assurance scheme which the contractor must institute to

demonstrate its performance of its obligations under the contract, and which the employer is

entitled to audit.119

Before each design and construction stage is commenced the contractor

must submit to the employer all procedures and compliance documents for that stage. This is

not only of benefit to the employer and financiers in gaining a fit project but for the contractor

who will be able to know at an early stage whether it is performing to the standard required.

However, financiers might also wish for an amendment requiring the employer to approve the

quality assurance programme, not just audit it.120

The contractor must also submit to the employer, at the contractor's cost, samples for review in

accordance with the procedures for Contractor's Documents.121

The employer and its

personnel must have full access to the site and are entitled at any time during production,

manufacture and construction to examine, inspect measure and test the materials and

117 Sub-Clause 7.1.


119 Sub-Clause 4.9.

120 As suggested by JA Huse, above n 23, at 172.

121 Sub-Clause 7.2.



workmanship and to check progress.122

Importantly for financiers, these inspections do not

relieve the contractor of any responsibility or obligation.

The employer is empowered by the variations provisions123

to vary the location or details of

specified tests or instruct the contractor to carry out additional tests, and if these varied or

additional tests show that the plant, materials or workmanship is not in accordance with the

contract, the cost of carrying out the variation will be borne by the contractor, regardless of

other provisions of the contract.124

UNCITRAL recommends adding a provision that failure of

the employer or contractor to discover a defect during testing does not relieve the contractor of

the responsibility of remedying the defect.125

The power to inspect and test is supplemented by the power to reject the plant, materials,

design or workmanship by giving notice to the contractor, with reasons, if they are found to be

defective or otherwise not in accordance with the contract.126

The contractor must then

promptly make good the defect and ensure that the rejected item complies with the contract.

The Yellow Book also provides that failure to comply with the employer's notice of rejection

within 28 days, without reasonable excuse, entitles the employer to terminate the contract.127

If this is to be included in the contract, financiers should insist they be involved in the

decision.128

The employer may instruct the contractor to remove and replace any plant or materials which

are not in accordance with the contract, remove and re-execute any other work which is not in

accordance with the contract, and execute any work which is urgently required for the safety of

the works, whether because of an accident, unforeseeable event or otherwise.129

If the

contractor does not comply, the employer may employ others to carry out the work and the

contractor must pay all costs arising from this failure in accordance with employer's claims

procedure, except to the extent that the contractor would have been entitled to payment for the

work. There is no provision for the contractor to repair the work without removing it. Under

122 Sub-Clause 7.3.

123 Clause 13.

124 Sub-Clause 7.4.


126 Sub-Clause 7.5.

127 Sub-Clause 15.2(c)(ii).

128 The necessity of financier involvement in contract administration is discussed further below, at section 3.4(d)(ii).

129 Sub-Clause 7.6.



the Yellow Book, the contractor must also comply within a reasonable time and the employer

is entitled to terminate the contract for failure to comply with the instruction within 28 days,

without reasonable cause.130

If parties wish to include this extra sanction in their contract,

financiers should ensure they have the power to approve or veto the employer's decision.

(e) Completion

(i) Tests on completion

Tests on completion occur upon completion of construction of the works and signal the

employer's take over and the commencement of the defects notification period in which the

contractor is responsible for remedying defects in the works. The tests on completion are

critical for the employer to ensure that the works constructed are fit for purpose and for

financiers to be certain that the project will produce revenue. Importantly, if the works do not

pass the tests, the contractor may still be liable for delay damages.

The Silver Book provides for 3 stages of testing by the contractor: pre-commissioning

(including that items are safe to operate), commissioning (that the works can operate safely

under all operating conditions) and trial operation (that the works perform reliably and in

accordance with the contract).131

Trial operation can also include additional tests including to

determine whether the works conform with criteria specified in the Employer's Requirements

and with the performance guarantees. The contractor must submit to the employer a certified

report stating that the tests have been passed. Huse suggests the employer would be able to

better monitor the tests if the contract required the contractor to develop and follow a particular

testing programme.132

If the works or a section of the works fail to pass the tests, Sub-Clause 7.5 applies, discussed

above, and either party may require the tests to be repeated under the same terms and

conditions. Under Sub-Clause 9.4, after repetition of the tests, if the works or section still fail

to pass, the employer may:

• order repetition of the tests;

130 Sub-Clauses 7.6, 15.2(c).

131 Sub-Clause 9.1.




• if the failure deprives the employer of substantially the whole benefit of the works

or section, reject the works or section and terminate the contract as a whole or in

respect of the major part which cannot be put to the intended use; or

• issue a taking-over certificate, signifying the works have been completed in

accordance with the contract.

If a taking-over certificate is issued, the contract price will be reduced accordingly and the

contractor must still comply with other obligations under the contract. The contract may state

the amount of this reduction or its method of calculation, or the employer may require both

parties to agree on the amount to be paid before the issue of the certificate, or determined and

paid under the procedure for employer's claims (Sub-Clause 2.5) and determinations (Sub-

Clause 3.5). This process should be acceptable to financiers, as it ensures that the works are fit

for purpose and operational and gives the employer considerable power. However, financiers

may wish to remove or amend the ability to reduce the contract price for works that do not

perform, as their objective is to attain complete performance. For this reason, Huse suggests

that lenders be given the power to review whether the contract price is reduced or the

contractor instructed to rectify the works. He also suggests lenders consider the effect of the

works not performing on the other agreements, such as the concession agreement.133

This is

another clause in which the financier's involvement is in its interests.

Financiers could further ensure the requisite standards are met by providing for bonus

payments if performance exceeds certain levels.

(ii) Tests after completion

The rationale for tests after completion is to ensure the plant meets performance criteria under

normal operating conditions, particularly where part of the works must meet an operational

standard. The contract should be explicit about what these standards are, and the tests used.

Lenders will be concerned to ensure that the minimum standards of performance are

appropriate. Parties should also allocate the risk of impossibility of meeting the minimum or

expected performance.134

Performance tests after completion are not mandatory in the Silver

Book, but if they are included in the Employer's Requirements, which financiers should ensure

they are,135

the following applies.






The tests must be carried out as soon as practicable after take-over, with the employer

determining the dates, in accordance with a set procedure. The contractor must compile and

evaluate the tests in a report.136

In contrast, in the Yellow Book the employer carries out the

tests and both parties compile and evaluate the results.137

While the Yellow Book model gives

the employer more control, the Silver Book more clearly allocates responsibility to the

contractor; financiers will have to determine which they prefer.

The contractor may claim for costs incurred as a result of unreasonable delay by the employer

to the Tests after Completion.138

It would be preferable to replace the vague standard of

"unreasonable delay" with a specific period of time, in order to reduce the potential for

disputes.

If the works fail to pass a test, the contractor must remedy the defect and either party may then

require the failed tests and tests on any related work to be repeated under the same terms and

conditions.139

If the contractor would be liable for the costs of remedying the defect under

Sub-Clause 11.2, and the employer incurs additional costs because of the failure and retesting,

the employer may claim for these additional costs. The Yellow Book is substantially the same,

except there is a narrower range of grounds of costs of remedying work for which the

contractor is responsible.140

The Silver Book also permits "deemed passing of tests". The works are deemed to have

passed a test if it cannot be completed during the defects notification period for reasons not

attributable to the contractor.141

The Silver Book also allows the works to be deemed to have

passed the tests if the contract provides for (or states a method for calculating) non-

performance damages and the contractor pays this sum to the employer during the defects

notification period.142

Additionally, a test is deemed to have been passed if, after a failure to

pass, the employer does not give notice to the contractor, before the expiry of the defects

notification period, of a convenient time to modify the works.










Financiers may wish to modify these provisions in a number of ways. Firstly, lenders and the

employer may want to ensure they get the standard of performance for which the employer has

contracted, by reducing the capacity of the contractor to pay damages in lieu of providing

complete performance.143

Secondly, financiers may also wish to abolish or limit the possibility

for tests for critical items to be deemed passed, given the importance of the works meeting

performance standards in a project financed project. Thirdly, lenders may wish to make

provision for circumstances that have rendered it impossible to pass a test. Under the Silver

Book, in this situation, the contractor's only obligation is the potentially futile one of having to

continue to repeat the tests. If the contractor does not do this, the employer may terminate the

contract. An alternative may be to allow the payment of non-performance damages instead of

termination where the passing of a test is impossible.144

It may be necessary to ensure that any

damages paid are consistent with damages that may be incurred through the other agreements

involved in the project.145

(iii) Defects notification period

The defects notification period is intended to ensure quality by requiring the contractor to

rectify defects notified during a period after take over. In the Silver Book, the length of the

defects notification period is one year, unless otherwise stated in the Particular Conditions, and

financiers may wish for this to be longer.146

Subject to the procedure for employer's claims set

out in Sub-Clause 2.5, the employer is entitled to an extension of the defects notification

period for the works or a section thereof if and to the extent that the works, section, or a major

item of plant cannot be used for the purposes for which they were intended because of a defect

or damage.147

The sub-clause limits this extension to no more than 2 years. However, for

certain projects, employers and financiers may wish to be able to extend the defects

notification period for more than 2 years.148

The Silver Book terminology of "defects notification period" rather than "defects liability

period" emphasises that the end of the period does not mean the expiry of the contractor's

liability itself, but only of the employer's ability to notify the contractor of a defect in order for




146 Sub-Clause 1.1.3.7.





it to be the contractor's responsibility. Parties should ensure they are aware of the effect of the

applicable local law on defects liability.

So that the works are in the condition required by the contract at the date of the expiry of the

defects notification period, the contractor must:

• complete any work stated to be outstanding in a taking-over certificate within such

reasonable time as is instructed by the employer; and

• execute all work required to remedy defects or damage as is notified by the

employer on or before the expiry date of the defects notification period.149

The employer can also require the contractor to search for the cause of any defect.150

The contractor thus may be obliged to remedy defects even after the expiry of the defects

notification period, if the employer notifies the contractor of the defect on or before the expiry

date. Under the Silver Book the contractor is responsible for rectifying all defects, not just

those it has caused. This is in financiers' interests, for if the contract provided that the

contractor was only responsible for remedying defects attributable to it, the employer would

have to use the variations clauses and thus be liable for additional costs or extensions of time.

It may be prudent, however to amend the sub-clause to expressly provide that a defect includes

an omission.151

Additional amendments to make the sub-clause more favourable to employers

could include adding a latent defects liability period, and allowing the employer to choose to

remedy the defect itself and then recover the costs from the contractor.152

Under the Silver Book, the contractor may receive costs for any remedial work unless and to

the extent that the work is attributable to:

• the design of the works;

• plant, materials or workmanship not being in accordance with the contract;



151 JK Hoyle, "The Rainbow Down Under - Part 1: Some Reflections from the Antipodes on Aspects of the New

FIDIC Design-Build Contracts" (2001) 18(1) International Construction Law Review 5 at 31-32.




• improper operation or maintenance which was attributable to matters for which the

contractor is responsible; or

• the contractor's failure to comply with any other obligation.153

Significantly, by stipulating the circumstances in which the contractor must bear the cost of

remedial work, the employer bears the burden of demonstrating that the circumstances fall

within the grounds specified. This is arguably inconsistent with the contractor's

responsibilities to design and construct to a standard of fitness for purpose.154

Additionally,

the sub-clause does not specify the result of the defect being attributable to the defective

design of the employer, and parties should clarify the allocation of responsibility for this in the

Particular Conditions.155

It is in financiers' interests for contractors to remain responsible for

costs of rectifying such defects.

The contractor must remedy any defect within a reasonable time; if it fails to do so, the

employer may fix a date on or by which the defect must be remedied, provided the contractor

receives reasonable notice of this date.156

If the contractor fails to comply with this later date

the employer may (provided the contractor would have been responsible for the cost of the

rectification):157

• carry out the work himself or by others at the contractor's cost (the contractor shall

have no responsibility for this work);

• agree or determine a reasonable reduction in contract price; or

• terminate the contract in whole or part if the defect or damage deprives the

employer of substantially the whole benefit of the works or any major part of the

works. The contractor is then liable, in addition to any other liabilities, to pay back

all sums paid for the works, to pay financing costs, and for the cost of dismantling

the works, clearing the site and returning plant and materials to the contractor.


154 JK Hoyle, above n 151, at 32.

155 JA Huse, above n 23, at 343. Note that the Yellow Book Sub-Clause 11.2 excludes rectification work

attributable to the employer's design from the contractor's risk and cost.





This last option gives the employer considerable power to effectively undo the work done and

oblige the contractor to put the employer back in the position he was at the start, although it is

somewhat difficult to imagine this option being used in practice, except reluctantly as a last

resort. It may be advisable for the financier to have a contractual role in the administration of

this provision, as its interests are liable to be detrimentally affected by the decision.

The contractor's obligations under the contract are only complete and the works are only

deemed accepted when the employer issues the Performance Certificate, stating the date on

which the contractor's obligations were completed.158

This must be issued within 28 days of

the latest of the expiry dates of the defects notification periods, or as soon thereafter as the

contractor has performed all required obligations, such as remedying defects. If the employer

fails to issue the certificate, it is deemed issued on 28 days after the date on which it should

have been issued.159

If this occurs, the contractor is not required to clear the site and may

claim additional expenses even though the final statement has been submitted. Financiers may

wish to press for this provision to be deleted, or require financier involvement in this function

to ensure a deemed issue of the Performance Certificate does not occur. Employers and

lenders may also wish to amend this sub-clause so that the contractor is still obliged to clear

the site where the certificate is deemed to be issued, as the present position seems unnecessary.

The employer may also require the provision to expressly state that the issuance of the

certificate does not exclude the contractor's continuing liability in contract or at law.160

(f) Quality risk under the Silver Book: conclusion

The Silver Book generally addresses the requirements of project finance in relation to quality

risks. All design risk is allocated to the contractor through the use of a fitness for purpose

standard and requiring the contractor to bear responsibility for verifying site data and the

occurrence of unforeseeable ground conditions. However, there are some minor amendments

which financiers may require, including limiting the areas for which the employer retains

design responsibility. The Silver Book also provides for reasonable employer monitoring of

quality and performance throughout construction and completion. However, financier

involvement in key decisions which could have a negative impact on the long-term

performance of the project asset would be beneficial.

3.4 Other risks for the financier


159 Note that the Yellow Book does not allow for the deemed issue of the performance certificate (Sub-Clause 11.9).




Within these broad categories of risk are a number of risks which deserve special mention

because their consequences may overlap between the various classes, or because their

occurrence is commonplace in construction projects.

(a) Variations

Variations give rise, or may be a response to, cost, time and quality risks. Quality is an issue

because the variation is an attempt to improve the design of the works. However, quality risks

may flow into time and cost risks: ordering variations will usually delay completion and may

entitle the contractor to remuneration for costs associated with the varied work. Financiers

thus have an interest in the contractual terms governing variations and in ensuring a balance

between the need for a revenue-producing project and the avoidance of delay to the

commencement of the revenue stream.

A variation is defined in the Silver Book as "any change to the Employer's Requirements or the

Works" which is instructed or approved under Clause 13.161

Sub-Clause 13.1 gives the

employer the power to initiate variations at any time prior to taking over by issuing an

instruction or requesting the contractor to submit a proposal. One restriction on this power is

that a variation may not comprise the omission of any work which will then be carried out by

others. The contractor is bound by a variation unless it promptly gives notice to the employer

with supporting particulars that:

• it cannot readily obtain the goods required;

• it will reduce the safety or suitability of the works; or

• it will have an adverse effect on the achievement of the Performance Guarantees.

The employer must then cancel, confirm or vary the instruction. This sub-clause gives the

employer significant power, and it has been suggested that this is inconsistent with the

contractor being bound to a fitness for purpose standard.162

Additionally, there is no restriction

that the variations instructed be within the scope of the contract.163

These factors make this

provision favourable to the employer and thus the financier.

161 Sub-Clause 1.1.6.8.


163 In contrast with some Australian standard form contracts: JK Hoyle, above n 151, at 35.



In addition to these employer-initiated variations, the contractor is empowered to make

proposals that would accelerate completion, reduce the cost to the employer of executing,

maintaining or operating the works, improve the efficiency or value of the completed works or

otherwise be of benefit to the employer.164

However, there are no incentives provided in the

contract for the contractor to share such information, as the contractor must prepare it at his

own cost and it could potentially reduce the contract price. It is in financiers' interests, in

obtaining a better product, to provide such incentives to the contractor.165

The procedure for variations is outlined in Sub-Clause 13.3. The employer may request a

proposal prior to instructing a variation, in which case the contractor must respond as soon as

practicable and give either:

• reasons why he cannot comply; or

• submit a description of the proposed design and/or work to be performed; a

programme for its execution; proposed modifications to the programme and time

for completion; and proposed adjustments to the contract price.

The employer, as soon as practicable after receiving this, must respond with approval,

disapproval or comments. However, the contractor must not delay work while awaiting this

response. The employer must issue to the contractor an instruction to execute a variation and

stipulate whether the contractor must record costs incurred, after which the contractor is

required to acknowledge receipt of the variation. The employer then agrees or determines

adjustments to the contract price and schedule of payments, in accordance with Sub-Clause 3.5

on determinations. These adjustments must include reasonable profit and, if applicable, take

account of the contractor's submission of the proposal to accelerate completion under Sub-

Clause 13.2.

As mentioned above, the contractor is entitled to an extension of time for an employer-initiated

variation.166

However, the procedure for contractor's claims in Sub-Clause 20.1 means that if

the contractor fails to give notice of the claim within 28 days, it will lose the entitlement to the

extension of time, or additional costs, so the employer may get the benefit of a variation for

free.167



166 Sub-Clause 8.4.

167 AH Gaede Jr, above n 108, at 500-501.



While the variations provisions allow the work to be improved at the employer's instruction,

the potential for variations to delay completion means that financiers should be closely

involved in the decision to instruct a variation.168

The Silver Book could also better encourage

contractor initiative.

(b) Notice provisions and determination of contractors' claims

Notice provisions, by facilitating the timely flow of information, are crucial in project financed

projects in which time is critical. In particular, where the contractor wishes to make a claim

for extra payment or an extension of time, it is desirable that the employer be in a position to

make enquiries as to the cause and extent of any delay or increase in cost, and consider its

position. Requiring notice to be given of claims is an effective method of ensuring this.

The precise form of provisions requiring notice will be of interest to the financier. Of

particular note is whether a notice requirement operates as a condition precedent to payment or

an extension of time, or whether the claim is not barred notwithstanding the failure to comply

with the notice requirement. In the Silver Book, compliance with notice provisions is a

condition precedent to consideration of a claim for additional payment or an extension of

time169

. That is, the contractor must give notice to the employer, describing the event or

circumstance giving rise to the claim, as soon as practicable, and not later than 28 days after

the contractor became aware, or should have become aware, of the event or circumstance.

Further, the contractor must submit any other notices which are required by the contract, and

supporting particulars for the claim as relevant to the event or circumstance. The contractor

must keep records that are necessary to substantiate the claim, and the employer may monitor

this record-keeping, instruct the contractor to keep further records, inspect the records, and

instruct the contractor to submit copies to the employer. Within 42 days after the contractor

became aware or should have become aware of the event or circumstance giving rise to the

claim, the contractor must give the employer a fully detailed claim with full supporting

particulars. This 42 day limit may be varied if approved by the employer. This procedure

should be satisfactory to financiers, particularly if there is provision for their involvement in

the employer's role. This would ensure that financiers are kept informed of potential claims

that could threaten cost or time certainty, and that all information regarding the circumstances

of the claim flows from the contractor to the employer to (ideally) the financier.

168 This will be examined more fully below at 3.4(d)(ii).




The determination process for claims is contained in sub-clause 3.5, which provides that the

employer shall consult with the contractor in an endeavour to reach agreement regarding the

claim, and "if agreement is not achieved the Employer shall make a fair determination in

accordance with the Contract, taking due regard of all relevant circumstances". The

requirement that the employer's determination be "fair", effectively gives the contractor an

additional ground to challenge the determination. From the financier's perspective it may be

preferable for this word to be deleted.

The determination process of contractor's claims outlined above should be reasonably

attractive to financiers for the following reasons:

• Time limit: the requirement that unless the contractor submit its claim within 28

days or else it is invalid prevents the employer, and consequently the financier,

from being indefinitely liable for valid claims;

• Discretion in determination: the determination of the claim is ultimately at the

employer's discretion if it is unable to agree with the contractor.

(c) Security

In project finance, the financiers will take security over the assets of the project. In reality,

however, such security is at best "defensive" in many infrastructure projects. By taking

security over those assets, financiers do not expect the value of those assets to cover the debt.

Security over the assets may, however, prevent third party interference with the assets and

allow the financiers to "pick up the pieces" of a project after insolvency. Under the Silver

Book, the financier will have recourse to the assets when legal title, free from liens and other

encumbrances, of the plant and materials passes to the employer, being the earlier of when it is

delivered to the site, and when the contractor is entitled to payment of the value of the plant

and materials.170

However, this is only to the extent consistent with the laws of the country,

and it would be advisable to seek advice on the impact of these laws on the financier's

interests. Importantly, however, where the asset has not yet been completed, and the financier

bears construction risk, the insolvency of the project vehicle poses large problems for the

financier. The assets over which they hold security are incomplete, and the cash-flows (from

which the debt was to be serviced) cannot be produced.

One solution is for the financier to take security over bank guarantees which are provided by

the contractor to the employer as security for the performance of the contractor's obligations

170 Sub-Clause 7.7.



under the construction contract. If the Particular Conditions state an amount, Sub-Clause 4.2

requires the contractor to obtain performance security for proper performance, at the

contractor's cost. The contractor must deliver this security to the employer within 28 days of

both parties signing the contract and the employer is able to approve the entity and jurisdiction

from which the security is issued. The employer also has the power to approve the form in

which it may be issued, if the form annexed to the Particular Conditions will not be used. The

contractor must ensure that the performance security is valid and enforceable until the

contractor has executed and completed the works and remedied any defects, including being

able to extend it if necessary.

The circumstances in which an employer may make a claim on the performance security are:171

• failure by the contractor to extend the validity of the performance security, in which

case the employer may claim the full amount of the performance security;

• failure by the contractor to pay the employer an amount due as either agreed by the

contractor or determined under the procedure for employer's claims (Sub-Clause

2.5) or the dispute resolution process, within 42 days;

• failure by the contractor to remedy a default within 42 days after receiving the

employer's notice requiring the default to be remedied; or

• circumstances which entitle the employer to termination under Sub-Clause 15.2,

irrespective of whether notice of termination has been given.172

However, the employer must indemnify and hold the contractor harmless against any loss,

damage or expense arising from a claim to the extent that the employer was not entitled to

make the claim. The employer must return the performance security to the contractor within

21 days of the contractor becoming entitled to receive the performance certificate.

The ability of the employer to control the nature and form of the security should be acceptable

to financiers. In addition, under the sample performance security annexed to the Silver Book

the employer does not need evidence that a precondition for a claim against the security has

been fulfilled. However, there is a loophole which reduces the ability of the employer to

promptly call on the performance security.173

As regards a claim on the performance security

171 Sub-Clause 4.2.

172 Termination is discussed below at 3.4(e).

173 AH Gaede Jr, above n 108, at 496-497.



due to the contractor's failure to pay an amount determined under employer's claims procedure,

the contractor may refer the question to the dispute resolution process, thus impeding the

employer's prompt recovery of security.

A financier would wish to call up this performance security in the event of a breach by the

contractor under the construction contract. To do this, the financier obviously needs to take

security over the employer's rights in respect of the performance security.

The security would contain provisions:

• preventing the employer accepting performance security without first obtaining the

financier's approval of the proposed issuer, the terms of the performance security

and the terms of the construction contracts (if any) regulating the rights of the

owner to make a demand under the performance security;

• preventing the employer varying the terms of any performance security or the terms

on which any performance security is held;

• preventing the employer, without the financier's consent, releasing the performance

security to the contractor except when and to the extent to which it is obliged to do

so under the construction contract;

• obliging the employer to deposit all moneys received by it under the performance

security into a nominated bank account; and

• restricting drawings by the employer from the bank account and entitling the

financier, in a default situation, to withdraw from that account any moneys to which

the employer is then absolutely entitled.

As well as taking security over bank guarantees, the financier may protect its interests through

having security over all the construction contracts. In this way, the financiers will be in a

position to step in and complete construction, and perhaps produce an asset capable of

generating the desired revenue stream.

By taking security over the employer's rights under the construction contract, a financier will,

in the event of a default, have a contractor already on site who has contracted to complete the

works for a specific price and within a specific time frame. This is beneficial not only to the

financier itself but also to anyone who then purchases the site from the financier.

Some of the provisions which would be expected to be in such a security include:



• an obligation upon the employer to perform its obligations under the construction

contract;

• the employer to advise the financier of any default by the contractor under the

construction contract or of any dispute with the contractor;174

• the employer to exercise or refrain from exercising its rights and remedies under the

construction contract in accordance with any direction from the financier; and

• the employer being prevented, without the consent of the financier, from exercising

its right to terminate the construction contract or agreeing to vary the construction

contract or the plans and specifications (at least where the variation may cause cost

or time blowouts or adversely change the quality or scope of the works).

Additionally, financiers should also consider having a direct contractual recourse to other

parties, such as the contractor, in order to safeguard their interests. For this purpose a

collateral contract may be useful. First, collateral contracts can provide the means by which

project targets can be adhered to in the event of the insolvency of, say, the project vehicle, or

the head contractor. It is possible to minimise, through collateral contracts, the need to

completely re-contract the project in order to bring it to completion. Second, collateral

contracts enable a party to recover damages for loss occasioned by the actions of another party

with whom that party would not normally be in a contractual relationship. In the absence of a

collateral contract the wronged party must rely upon much less certain remedies such as tort or

trade practices/fair trading legislation.

There are three parties with whom financiers may wish to have a collateral contract: the

contractor, subcontractors and consultants.

A key provision of a collateral contract with the contractor would be an undertaking by the

contractor not to terminate the construction contract as a result of default by the project vehicle

without first giving the financier an opportunity to remedy the default. Such "cure" provisions

are common to other project finance documents as well. The contractor's side agreement

would also contain a provision entitling the financier to assume the employer's rights and

obligations, in effect, under the construction contract in the event of a default by the employer

under the debt agreement. Alternatively, there could be provision for a third party to

completely take over the project company's rights and obligations under the contract.

174 Such default would hopefully also come to the knowledge of the financier as a consequence of its participation in

contract administration.



The objectives behind this agreement are to secure the funds advanced by the contractor and to

ensure the successful completion of the project without the need for the financier to arrange for

another contractor to complete the works. If the financier were forced to take this course of

action, many attendant delays and additional costs would materialise. From the contractor's

point of view, it will usually be secure in the knowledge that if the employer defaults and the

financier wishes to complete the project, it has a good chance of being paid for the work

carried out to the date at which they became entitled to terminate or suspend the construction

contract. Additionally, by completing the project for the financier in the event of the

employer's default or insolvency, the contractor secures its profit for the whole of the project

works.

The financier may also include other useful provisions in the collateral contract made with the

contractor. For instance, it is advisable that it contain a provision obliging the contractor to

include in each subcontract a provision that where the contractor is in default under the

construction contract the employer, or, where the employer is in default under the debt

agreement, the financier, may take an assignment of the subcontract.

In relation to assignment of the subcontracts, the financier can go one step further and enter

into a collateral agreement directly with the subcontractors. This is preferable from the

financier's point of view particularly in the situation where both the employer and contractor

become insolvent. Such agreements should give the financier the right to require the

subcontractors/suppliers to agree to an assignment of their agreement from the contractor to

the financier or its nominee.

A financier may also wish to enter into a collateral agreement with the design consultants, in

order to provide the financier with a contractual remedy against the consultants where loss has

been occasioned by defective design.

Such a collateral contract provides some measure of protection to a financier where it is

necessary to "build out" of the difficulties rather than to dispose of the security in its existing

condition.

(d) Intervention

(i) By the Employer

The Introductory Note states "the Contractor should be given freedom to carry out the work in

his chosen manner, provided the end result meets the performance criteria specified by the

Employer. Consequently, the Employer should only exercise limited control over and should

in general not interfere with the Contractor's work". However, the Silver Book itself allows



the employer considerable scope for involvement in the execution of the works. While these

provisions help ensure the employer gets the project for which he contracted, if too excessively

used they can be counter-productive and impede timely progress. Therefore, while the

financier will prefer the balance of power to favour the employer, it would be wise to ensure

the financier is involved in the decision to interfere. In addition, from the contractor's

perspective, the provisions are a controversial inclusion in a turnkey contract, so financiers can

expect resistance in the negotiation of the contract.

The Silver Book gives the employer power to issue "instructions which may be necessary for

the Contractor to perform his obligations".175

Such an instruction may constitute a variation, in

which case the variations provisions apply.176

This sub-clause has significance, for when used

in combination with other provisions it allows the employer to interfere in the manner in which

the contractor performs its obligations. For example, as already discussed, the Silver Book (in

contrast with the Yellow Book) limits the employer's powers to reviewing, not approving, the

Contractor's Documents.177

However, the employer could use its power to issue instructions to

further control the Contractor's Documents, despite the ostensible design responsibility of the

contractor. This power is also problematic for the contractor because of the ambiguity of

instructions "which may be necessary"; it seems likely to invite dispute. One author has

suggested clarifying the provision and more strictly confining the employer's power to issuing

instructions which are necessary and are contractual.178

Another area in which the employer may interfere is to use the variations clauses to nominate a

subcontractor.179

The contractor may only refuse if it raises reasonable objection by notice to

the employer as soon as practicable, accompanied by supporting particulars. This enables the

employer to control the quality and price of subcontracted work, while the contractor retains

liability. Gaede argues this is inappropriate for a turnkey project given that the contractor

bears the risks and responsibilities of their actions. He also suggests that parties will debate the

meanings of "reasonable objection", "as soon as practicable" and "supporting particulars".180

Also, the rationale of lowering cost is less applicable to a lump sum turnkey contract.

175 Sub-Clause 3.4.

176 Discussed above at section 3.4(a).

177 Sub-Clause 5.2.

178 AH Gaede Jr, "Letter to the editor: FIDIC Conditions" (2001) 18(4) International Construction Law Review 703

at 707.

179 Sub-Clause 4.5.

180 AH Gaede Jr, above n 108, at 482.



Otherwise, as the Silver Book contains no requirement that subcontractors be approved by the

employer, financiers might wish for the inclusion of some sort of consent procedure, as in the

Yellow Book where all subcontractors not named in the contract must be approved by the

engineer.181

This would enable greater control over the quality of the work.

As discussed above,182

the employer may instruct the contractor to accelerate if the contractor

has fallen behind the programme or actual progress is too slow to complete on time.183

Contractors argue that they should be allowed to be behind as long as they complete on time,

which is in their interests after all to avoid liability for delay damages. However, the

importance of certainty of time in project financed projects means this provision is important.

Additionally, this is less unreasonable than some have asserted:184

the programme to which the

contractor must adhere will not be out-of-date as the contractor has an obligation under Sub-

Clause 8.3 to submit revised programmes whenever the previous programme and actual

progress are inconsistent.

The Silver Book provides that the contractor must submit monthly progress reports to the

employer, enabling the employer to monitor progress and the quality of the work.185

The

contents of the progress reports are required to be quite detailed and have been criticised as

placing too onerous a burden on contractors, particularly if the employer has an Employer's

Representative on site who will be keeping the employer informed as well.186

Lenders may

wish to have access to the progress reports.

Other provisions that involve the employer in the execution of the works that have been

discussed above include:

• employer review of the drawings and documents that the Employer's Requirements

require to be submitted;187

• inspection rights,188

which Gaede believes this is often a method of undue

interference by employers.189

181 Sub-Clause 4.4.

182 At section 3.2(c).

183 Sub-Clause 8.6.

184 See for example NDJ Henchie, above n 55, at 48-49.





• rejection of the plant, materials, design or workmanship and instruction to retest;190

and

• instructions to conduct remedial work.191

While financiers and employers will be happy with this ability to control the project, these

provisions have been criticised as incompatible with the fitness for purpose standard and the

allocation of risk to the contractor in the Silver Book and turnkey contracts generally.192

However, Christopher Wade, who was Chairman of FIDIC's committee for International

Contract Conditions at the time of the drafting of the new suite, has defended the Silver Book

model of employer interference. He acknowledges that undue interference by the employer

can have time and costs impacts on the contractor, but argues that having no control over the

contractor could result in an unfinished project. He believes that the problem of contractors

underperforming is equal to the risk of undue interference by the employer. The employer has

a right to know that time, cost and quality are being complied with.193

He notes that parties

can delete or modify the relevant clauses if they are unhappy with them, or if, as the

Introductory Note observes, the employer wants to have greater supervision of the contractor's

work or construction drawings.194

Employer control may also be necessary given that

contractors may be concerned only with short-term profitability and minimum standards,

rather than the long-term quality requirements of the employer and the financier.

(ii) By the lender

For many purposes it is useful to consider the financier's position as more or less equivalent to

that of the owner or project vehicle, in that it desires to contain cost, and ensure timely

completion and quality.

187 Sub-Clause 5.2.

188 Sub-Clause 7.3.

189 AH Gaede Jr, above n 108, at 483.

190 Sub-Clause 7.5.

191 Sub-Clause 7.6.

192 E Corbett, above n 70, at 269-270; J Delmon and J Scriven, "A Contractor's View of BOT Projects and the

FIDIC Silver Book" (2001) 18(2) International Construction Law Review 240 at 243; AH Gaede Jr, above n 108, at

479, 501; JK Hoyle, above n 151, at 17.

193 C Wade, above n 108, at 512-513.

194 C Wade, above n 108, at 511-513.



However, the financier is somewhat removed from the administration of the contract, and

without adequate provision being made, may not be able to safeguard its interests in the same

manner as may the project vehicle. For this reason, it is important that financiers bargain for

an opportunity to participate meaningfully in contract administration, in particular the

employer's power to intervene in the execution of the works.

The financier, if it is to participate fully and constructively in the process of contract

administration, must have access to the information it requires to make informed decisions.

Mandatory reporting obligations will generally be placed on the project vehicle, as it will

typically be in the best position, apart from the contractor, to gauge the progress of the works.

In this manner the financier can be kept abreast of developments and potential problems,

hopefully for any difficulties to be overcome.

The problem will often remain, however, that the lender is reliant on other parties for the raw

information that they require. One method of overcoming this problem is for lenders to

engage the independent certifier or contract administrator jointly with the project vehicle on

some projects. In this manner, the contract administrator/independent certifier will be to some

extent required to take into account the interests of the financier when certifying work done

under the contract. This helps to ensure that the financier is kept informed and that the

financier's interest is taken into account by the independent certifier when important matters

are certified, such as completion.

Lenders may wish to have direct involvement in contract administration through the

appointment of a lender's engineer or technical adviser who could exercise some control over

matters of particular concern to lenders, such as extensions of time, variation, and testing. This

would also require provisions for access and inspection. However, the amendments should

endeavour to minimise the potential for such involvement to be counter-productive and

delaying.195

One area in which financiers should take an active role is with regards to variations. As

discussed above,196

variations have the ability to impact on all three key areas of risk. While

variations are almost bound to occur in any sizeable project, their consequences should not be

overlooked. A large number of variations and consequent extensions of time over the life of a

project may lead to a cost blow-out, which may place a lender in an invidious position, being

forced to lend more funds solely to ensure that the project does not flounder. For this reason a


196 At section 3.4(a).



lender should have a right to approve all variations before they are ordered. By ensuring that

no variation may proceed without the financier's consent, the potential for variations to

detrimentally affect the lender's financial position is reduced.

It should be noted that many variations may be in the best interests of all parties. Often, a

variation will be made which will improve the quality of the project, or reduce long term

maintenance costs. In such a case, it may not be productive for the financier to exercise their

rights to veto changes in the works. The financier should accordingly ensure that it exercises

any rights it has regarding variations only when fully appraised of the circumstances

surrounding the variation.

Financiers have a legitimate interest in contract administration, and accordingly, they should

be willing to participate actively in contract administration issues.

(e) Termination of the contract

Though termination of the construction contract for the default of one of the parties is likely to

be fatal to the project, adequate provision in the contract for termination may facilitate

successful re-tracking. In major projects, the circumstances in which the contract allows

termination ought to be well defined. If one party purports to terminate a contract, and this

purported termination is wrongful, the terminating party has repudiated the contract. To avoid

the uncertainty associated with the common law position, detailed contractual provisions

regarding when a party may terminate for default may be used to great effect. Thus, when a

contractor is in default, the contract may be readily terminated and the defaulting contractor

replaced before the project is irreparably harmed. However, termination provisions should be

drafted to be consistent with other project agreements, such as the concession agreement.

(i) Termination by the contractor

The contractor is entitled, after giving notice, to suspend work if the employer is late with

payments or fails to give evidence of financial arrangements as required by Sub-Clause 2.4.197

However, the contractor must resume work as soon as is reasonably practicable once the

employer subsequently gives the evidence or makes the payment.

Under the Silver Book the contractor may terminate the contract after giving 14 days' notice to

the employer if:198





• the contractor does not receive reasonable evidence of the financial arrangements of

the employer within 42 days of giving notice to suspend under Sub-Clause 16.1;

• the contractor does not receive a payment within 42 days of the expiry of the time

in which the payment is to be made;

• the employer substantially fails to perform its obligations under the contract; or

• the employer fails to comply with Sub-Clause 1.7, prohibiting assignment without

consent of any benefit or interest under the contract.199

This notice provision should be significant when the notice periods of the referred sub-clauses

are accumulated. However, financiers could request that the contractors give notice of

intention to terminate to the financiers so step-in rights could be exercised. Financiers should

also ensure that for these events there is express provision that if the employer cures the

default during the notice period the termination is annulled.200

The contractor may by notice terminate the contract immediately if:

• a prolonged suspension affects the whole of the works as described in Sub-Clause

8.11; or

• the employer becomes bankrupt or insolvent, goes into administration, has a

receiving or administration order made against him, compounds with his creditors,

or carries on business under a receiver, trustee or manager for the benefit of his

creditors, or if any act is done or event occurs which (under applicable laws) has a

similar effect to any of these acts or events.201

The Silver Book provision in Sub-Clause 16.4 for compensation to the contractor if the

contractor terminates the contract is broader than is usual in project finance; in particular the 5

aspects for which the employer must pay the contractor following termination following a

199 Sub-Clause 1.7 prohibits either party from assigning the whole or any part of the contract or any benefit or

interest under the contract, except with the prior agreement of the other party (at the sole discretion of that party)

and assigning its rights to moneys due under the contract as security in favour of any bank or financial institution.





force majeure event do not reflect practice, where the employer and the contractor normally

split the risk.202

(ii) Termination by the employer

If the contractor fails to carry out any obligation under the contract, the employer may by

notice require the contractor to remedy the failure within a specified reasonable time.203

This

is a wide power as it is not limited to failure to carry out a material obligation but covers any

obligation.

Under the Silver Book, the employer may terminate the contract after giving 14 days' notice to

the contractor if the contractor:

• fails to comply with the notice to correct under Sub-Clause 15.1;

• fails to comply with Sub-Clause 4.2 on performance security;

• abandons the works or otherwise plainly demonstrates the intention not to continue

performance of his obligations under the contract;

• without reasonable excuse fails to proceed with the works in accordance with

Clause 8 on Commencement, Delays and Suspension; or

• subcontracts the whole of the works or assigns the contract without the required

agreement with the employer.204

The employer may terminate the contract immediately if the contractor:

• becomes bankrupt or insolvent, goes into administration, has a receiving or

administration order made against him, compounds with his creditors, or carries on

business under a receiver, trustee or manager for the benefit of his creditors, or if

any act is done or event occurs which (under applicable laws) has a similar effect

to any of these acts or events; or

202 M Wahlgren, "Delivering Infrastructure: International Best Practice - FIDIC Contracts: A Developer's View",

August 2002, (paper based on a talk given to the conference "Delivering Infrastructure: International Best Practice"

organised by the Society of Construction Law, Centre of Construction Law at King's College, London, European

Society for Construction Law and Society of Construction Arbitrators and held in London on 12th July 2002)

available at www.scl.org.uk/papers/papers99on.php, at 5-6.




• gives or offers to give (indirectly or directly) to any person any bribe, gift, gratuity,

commission or any other thing of value, as an inducement or reward:

• for doing or forbearing to do any action in relation to the contract; or

• for showing or forbearing to show favour or disfavour to any person in

relation to the contract,

or if any of the contractor's personnel, agents or subcontractors does so. Lawful

inducements or rewards to contractor's personnel shall not entitle termination.205

The employer may then complete the works and/or arrange for others to do so, and they may

use any goods, contractor's documents or design documents made by or on behalf of the

contractor. Upon termination for cause pursuant to Sub-Clause 15.2, the employer may still

proceed with any employer's claims he has, withhold payments to the contractor until costs

owed to the employer have been established, and/or recover any losses or damages from the

contractor.206

Again, the parties should clarify whether the contractor's cure of the default during the notice

period annuls the termination. Given the expense and disruption to the project caused by

termination, it may be in the financiers' interest to allow the contractor to cure the default and

continue.

The employer is also entitled to terminate the contract for the employer's convenience, with

effect 28 days from the later of the date of giving notice or returning the performance

security.207

However, the employer may not terminate under this provision in order to execute

the works himself or arrange for the works to be executed by another contractor. This is a

powerful provision, the exercise of which may not necessarily be in the financier's interests.

The financiers should ensure that the employer has to gain their consent before terminating the

contract.

204 Sub-Clause 15.2. The Yellow Book provides two addition grounds for termination by the employer: failure to

comply with a notice within 28 days issued under Sub-Clause 7.5 (Rejection) or Sub-Clause 7.6 (Remedial Work).

Huse suggests that the omission of these in the Silver Book is a printing error: JA Huse, above n 23, at 453..






4. Does the Silver Book go far enough for financiers?

It has been suggested that, compared with the project finance construction contracts which are

normally used, the Silver Book still favours the contractor.208

In addition to those already

highlighted, from the financier's perspective, there are a number of inadequacies in the Silver

Book, and parties should consider making some amendments in order to better address the

financier's requirements. The contract should be drafted to be in harmony with the concession

contract. For example, definitions of force majeure and "change in law" should be consistent

so that the contractor's entitlements under the construction contract are the same as the

employer's entitlements under the concession contract. Similarly, termination and inspection

provisions should work together and lenders may wish to make contractors' claims contingent

on the employer recovering under the concession contract.209

A number of amendments would more directly protect the financiers' rights and make the

Silver Book more acceptable for financiers. Firstly, potential cost overruns could be catered

for by sponsors or the contractor (particularly if it is also one of the sponsors), providing a

stand-by line of credit.210

Secondly, the financier may oblige the contractor to undertake not to

do anything inconsistent with the financier's interests under the loan and security

documentation.211

This could include a requirement that payments to the contractor are made

subordinate to payments to the financier. Thirdly, the financier could request the inclusion in

the construction contract of some of the employer's obligations that would typically be in the

lending agreement, including guarantees not to amend or waive rights under the construction

contract, or substantially changing the project plans, without the consent of the financier.

The Silver Book could also be improved by eliminating some of the vague and ambiguous

standards where they are imposed against the employer/financier. For example, where

particular performance standards are required to achieve the level of revenue, these could be

specified in the contract. Additionally, the Silver Book's frequent use of a standard of

reasonableness increases the potential for disputes over what is "reasonable" in the

circumstances, which is not in the interests of financiers or the project.212

208 M Wahlgren, above n 202, at 6.




212 A standard of reasonableness is used in Sub-Clauses 2.1, 2.2, 2.4, 4.5, 4.6, 4.8, 4.15, 4.18, 4.24, 6.7, 6.11, 7.3,

7.4, 8.5, 10.3, 11.1, 11.4, 11.8, 12.2, 12.4, 15.1, 15.2, 16.1, 16.2, 18.2, 18.3, 19.1, 19.3, and 19.6.



5. What is the practical application of the Silver Book?

The Silver Book was a response to a perceived bargaining strength of financiers and a need,

therefore, to make the Silver Book practical, by reflecting that market climate. Since it was

published, however, the market has changed: contractors are in a stronger position.

Previously, an excess of contractors forced them to assume significant risks, incur greater costs

in bidding, and obtain lower profits, usually less than 2% of the contract value.213

The

decrease in competition among contractors means that contractors now have more power to

choose their projects and negotiate terms, which has a significant impact on project finance.214

The Silver Book model of satisfying lenders' demands for certainty of cost and completion by

shifting most risk onto the contractor may not be applicable in the current environment. In the

Middle East, for instance, EPC contractors are demanding flexible cost reimbursement

contracts where cost increases are shared with the sponsor.215

Contractors, particularly

established contractors, may not be willing to bid on a competitive lump sum turnkey basis.216

Consequently, new strategies have recently developed that replace cost certainty with

flexibility:

• The contractor is retained on the basis of experience and man-hour rates and

prepares a lump sum estimate on a reimbursable basis, then under the contract

converts the estimate into a fixed price.217

• The "target price approach" or "guaranteed maximum price" contract (for the whole

project or part thereof). Sponsors share savings with the contractor if the actual cost

is less than the guaranteed maximum price, but the contractor bears the risk of

actual cost exceeding the guaranteed maximum price. This encourages the

contractor to be cost-effective, and contractors have been happy to contract on this

basis.218

213 J Jenkins, P Leighton and J Staigerwald, "Current Trends in EPC costs", in Rod Morrison (ed), Project Finance

International Yearbook 2006, Thomson Financial, London, 2006, at 11.

214 A Campomar, "What Price Chemicals?" (2006) 269 Project Finance 47 at 48; J Jenkins, P Leighton and J

Staigerwald, above n 213, at 15.

215 Michael Marray, "Backseat Drivers", (2006) 267 Project Finance 62 at 62.

216 A Campomar, "What Price Chemicals?" (2006) 269 Project Finance 47 at 48.

217 J Jenkins, P Leighton and J Staigerwald, above n 213, at 15-16.

218 J Jenkins, P Leighton and J Staigerwald, above n 213, at 15-16; M Lucas, "Old Risks - New Contracts" (2006)

271 Project Finance 32 at 32-33.



• EPCM (engineering procure and construction management) contracts, in which

more efficient pricing is achieved through the sponsor bearing the fundamental

process design risk. However, lenders usually require sponsors to expose their

balance sheets for the purposes of completion risk.219

• Where financiers retain a preference for a lump sum turnkey contract, these

alternative models may be coupled with sponsor guarantees or only using

contractors with a proven track record of completing on time and to cost.220

These market changes, combined with the unfavourable perception of the Silver Book, work

against its use as a standard form contract for project finance. Some authors have suggested

that the Silver Book, alone of the new FIDIC contracts, is not used regularly due to its

reputation as "draconian".221

Notably, the current World Bank Standard Bidding Document

for the supply and installation of plant and equipment, which has been revised since the Silver

Book, is based on a contract favourable to the contractor - the Model Form of International

Contract for Process Plant Construction published by the Engineering Advancement

Association of Japan - rather than the Silver Book. It has been suggested that this may be

partly due to the general criticism of the Silver Book by contractors.222

The perception of the

Silver Book as unfair and draconian means that it is not accepted as a starting point for

negotiation, as it is intended to be, and parties are instead amending the Yellow Book for their

purposes.223

Contractors are not agreeing to use an unamended Silver Book unless the

employer has significant influence.224

Both parties seem to prefer the Yellow Book, or

alternatively, developers' bespoke forms of contract which they are accustomed to using (and

which require less amendment than the FIDIC suite).225

In this respect, the Silver Book could

be said to have failed, as it was the use of these bespoke contracts and the need for a standard

form that prompted the drafting of the Silver Book in the first place. This perhaps highlights

219 M Lucas, "Old Risks - New Contracts" (2006) 271 Project Finance 32 at 33.

220 M Lucas, above n 219, at 33.

221 NDJ Henchie, above n 55, at 42-43.

222 M Bell, "Will the Silver Book Become the World Bank's New Gold Standard? The Interrelationship Between the

World Bank's Infrastructure Procurement Policies and FIDIC's Construction Contracts" (2004) 21(2) International

Construction Law Review 164 at 168.

223 NDJ Henchie, above n 55, at 43.

224 M Bell, above n 222, at 171.

225 M Wahlgren, above n 202, at 8.



the danger of FIDIC moving away from its traditional balanced risk allocation, even where it

aims to reflect changes in construction practice.

6. Conclusion

It is necessary to identify the legitimate requirements of financiers and whether the Silver

Book provides them, for if contractors are not prepared to address them, lenders will refuse to

finance the project. However, financiers need to be aware of contractors' concerns in order to

be prepared for contract negotiation. All parties must have a detailed understanding of risk so

that the contract can reflect the risk allocation they desire.

In general, the use of standard form contracts is beneficial to project finance as it increases

certainty in risk allocation through familiarity and awareness of which terms to negotiate. Of

course, parties should tailor the contract to suit the project, not vice versa, and should also be

aware of where a standard form contract is interpreted differently in different jurisdictions.

The Silver Book is favourable towards the employer, which indirectly benefits the project

financiers. Although requiring some amendment, it generally addresses project finance

requirements relating to cost, time and quality risks. However, where the Silver Book falls

down is in the failure to provide a role for the financier, given that the interests of financiers

and employers are not always aligned. In light of the considerable discretion conferred on the

employer in aspects of contract administration and intervention in the execution of the works,

financiers should have a contractual role in ensuring this discretion is not exercised to the

detriment of financiers' interests. Arguably, in attempting to maximise the application of the

Silver Book beyond project finance, FIDIC has failed to address the complexity of a project

financed project and the interaction of the construction contract itself with other parties and

agreements in the project.

Ultimately, however, the terms to which financiers and contractors are going to agree will

depend on the market. The current contractor's market means contractors are unlikely to even

agree to a lump sum contract as provided in the Silver Book. Skewing a contract too much one

way means not only that it lends itself to "mutilation" but more detrimentally that it will not be

used at all - as is the present case with the Silver Book. It may be that sponsors need to

consider exposing their own balance sheets to a limited degree to protect financiers until the

project is delivered and then revert to revenue from the completed project as the source of debt

repayment.

© Doug Jones 2006.



7. Appendix 1: Delivery models and their approach to risk

Delivery model General features Approach to risk

Traditional lump sum Construct only

Contractor bears risk of cost overruns

However, lump sum may be subject to:

• escalation for part or all of contract period

• adjustment (due to variations, delay latent conditions etc)

Adjustment provisions cause some out-turn

cost risk to be shared with owner/financier

Contractor has no responsibility for design

(and duty of consultants is less onerous

"reasonable care" duty)

Design & Construct

(D&C)

Single line responsibility for design and

construction

Appropriate where:

• Owner's priority is best design for a

price; and

• Concept design and design brief are sufficiently developed to ensure

delivery of the required product

Increased contractor liability for design

defects (fitness for purpose)

Possible to place greater burden for time and

site condition risks upon contractor:

• eg, requirement to "design around"

unforeseen conditions

• Greater control allows risk of neutral events (impacting on time and cost) to be

better predicted and managed

• Buildability studies and value

management measures

Design Construct

Maintain/Operate

Combine delivery and

operation/maintenance structures

Developed to increase contractor

responsibility for the "maintainability"

of a facility

Limited pool of contractors capable of

committing?

Difficulty specifying precise O&M

requirements at time of tender may lead

to uncompetitive tenders

As for D&C

Plus contractor's obligation to carry out

corrective maintenance without remuneration:

• Gives owner greater protection against defective design or construction

• Allows transfer of neutral risks (eg, force

majeure, security) to contractor for a

significant period after completion

Turnkey Lump sum - design, construction and

commissioning

Contractor hands over operating facility

(eg, power station)

Commissioning is a critical stage from

PF perspective, as it is at this point that

facility becomes revenue producing

Contractor bears responsibility for design and

construction

Employer has less control

Engineering

Procurement

Construction

Management

Engineering firm co-ordinates delivery

through design, construction and

commissioning stages

Usually remunerated on a fee for

service basis

High degree of owner control:

• Trade contractors enter into direct contractual relationship with owner

once work is let

Example of project delivery by a low risk

manager:

• Contractor is assigned the role of managing the work of various trade

contractors

• Fee based remuneration transfers most

risks away from manager

In return, owner/financier has large degree of

control



Delivery model General features Approach to risk

Direct contractual relationship with

contractors gives owner direct contractual

recourse for defective work

Partnering Moral, non legal arrangement

emphasising trust, mutual objectives,

fair dealing, good faith and cooperation

Can be implemented in respect of any

contracting strategy

Risk that informal undertakings will give rise

to equitable duties of good faith or merely

"gloss over" what remains an inherently

adversarial relationship

Managing contractor Essentially a D&C contractor

responsible for delivery from feasibility

through to commissioning

Differs from D&C contractor in terms

of role and risk:

• Usually subcontracts all design and construction obligations in close

consultation with owner

Captures some benefits of lump sum

D&C delivery whilst maintaining a

high degree of owner control

Lower cost and quality risks than lump sum

D&C contractor:

• Cost - Lump sum + reimbursable remuneration. Costs incurred through

MC's default not reimbursed (achieves

accountability)

• Quality - MC not subject to fitness for

purpose warranty (separate obligations in

respect of design and construction)

Owner/financier's risk exposure far greater

than under traditional model (but also greater

control to manage risk)

Extensive consultation may add to time and

cost

Alliance Project alliances:

• Project based

• Applies to a specific scope of

works

Strategic alliances:

• Long term relationship

• Performance of routine and

ongoing work

• Series of similar or related projects

• "Core" workload + evolving scope

Aim to create environment where it is in both

parties' financial interests to co-operate:

• Must provide incentives to perform and incentives to co-operate

• Remuneration structure must not subvert

the risk allocation of the parties

Alliances may be a potential trap for financier

where there is:

• Poorly defined risk allocation

• Unpredictability as to out turn cost

© Doug Jones 2006.