BuildLaw - Issue No 11 Sept 2011FIDIC GOLD BOOK CONTRACT GUIDE 1

BUILDING DISPUTES TRIBUNAL www.buildingdisputestribunal.co.nz

1. Introduction
The International Federation of Consulting Engineers (FIDIC)
has just published the latest in their series of Contract
Guides, this time in relation to the new Design, Build and
Operate form (FIDIC "Gold Book"). FIDIC Gold Book remains
the only internationally recognised design, build and operate
standard and so not surprisingly was the subject of much
discussion from industry commentators when first published
(in 2008). At the time, criticism was directed in particular to
the clauses dealing with project operation (a first for FIDIC),
the fact that it is reserved for greenfield projects and that it
has no funding element. It was hoped that the Contract
Guide might address some of these issues and in doing so
widen its potential application for future projects.
In this [Newsflash/article] we examine several of the key
criticisms raised against the Gold Book and consider whether
these have been addressed in the Contract Guide.

NEW FIDIC GOLD BOOK
CONTRACT GUIDE

-Sarah Thomas
Partner at Pinsent Masons
AUTHOR PROFILE





Sarah Thomas is a partner with
international law firm Pinsent Masons
(www.pinsentmasons.com),
specialising in infrastructure projects
both in the UK and overseas and has
extensive experience of using and
adapting all FIDIC forms - particularly
in the water, waste, energy and mining
sectors. Sarah can be contacted
direct on
[email protected] or
+44 (0)207 490 6273

2. Applicability for Brownfield Sites and BOT/PPP Projects

FIDIC Gold Book states in its introduction that it is applicable only to greenfield sites and has no
provision for upgrade of existing facilities. As these types of projects make up only a relatively small
portion of DBO projects in general, it was hoped that the Contact Guide would include the much
promised changes to make the Gold Book suitable for brownfield sites as well. However, we will have to
wait a bit longer for this as according to the Contract Guide: "FIDIC intends to publish a separate
document for the brownfield scenario."


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Another key issue noted when the Gold Book was first released (particularly in the UK), was the lack of
any financing element, which ultimately makes the form unsuitable for PPP/BOT projects. Likewise,
provisions to adapt the Gold Book for PPP/BOT are not included in the Contract Guide. It is also
doubtful that the form could be used even as a subcontract in a BOT/PPP project, since such
subcontracts would need to be on a back-to-back basis with the overarching project agreement, and so
would only be suitable following substantial amendment.

3. Contractor Obligations Over the Operation Period

In the Foreword to the Gold Book, FIDIC envisaged that it would be used by separate construction and
operating companies acting as the "Contractor" under a joint venture/consortium agreement. However,
imposing obligations on the JV/Consortium as a whole causes particular problems in a DBO project.
Consider Sub-Clause 4.1 of the Gold Book. This imposes a duty on the Contractor to ensure that the
Works are "fit for the purposes for which the Works are intended as defined in the Contract" and states
that the "Contractor shall be responsible for ensuring that the Works remain fit for such purposes during
the Operation Service Period" [Emphasis added]. Construction companies have a business model that
relies on design/build risk being significantly decreased on issue of the completion certificate. Such
companies will have to consider carefully their continuing exposure over the 20 year Operation Service
Period. Operators have a long term risk model, but are reliant on the design and build expertise
provided by the constructor and would not ordinarily assume fitness for purpose in their O&M contracts
(which are service contracts that are output focussed after all). Operators would therefore find it difficult
to model the construction risk without guarantees from the constructor, with such guarantees dependent
on the projected financial viability of the constructor over the 20 year Operation Service Period.

In addition, under Sub-Clause 4.2 of the Gold Book, performance security must be provided by the
Contractor throughout both the design-build and operational phases of the project. Despite the value of
the bond being reduced 1 year following the completion of outstanding construction works, this provision
may be onerous to the Contractor (depending on the type of project and value of the bond). It has been
questioned whether an institution will provide such long term guarantees, and whether the reduced risk
following commissioning still justifies such protection. This is especially the case when Sub-Clauses 4.25
and 15.2(e) already provides a mechanism under which the Contractor must report any adverse changes
in its financial situation and allows the Employer to terminate the contract if the Employer believes the
Contractor will not satisfy its financial obligations. Therefore a Contractor renewing the necessary bond
coverage not only faces the increased cost of renewing, but should such cost be prohibitive, the
Employer has the right to terminate. Thankfully this is one issue which the new Contract Guide does
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address. The Guide acknowledges that: "some Employers may choose not to require a Performance
Security during the Operation Service Period as they may see this phase of the Contract as being
equivalent to a "service contract" where a Performance Security is not appropriate". This provides strong
justification for a Contractor to resist providing a performance security for the Operation Service Period.

4. Reporting Criteria

The Contract Guide is less helpful on the interpretation of provisions dealing with monthly reporting. The
position is clear during the construction period. Sub Clause 4.21 states that during the design-build
phase monthly progress reports are to be submitted and that "reporting on progress shall continue until
the Contractor has received the Contract Completion Certificate. However the contract is silent on
frequency during the operations phase. The clause goes onto say: "Details of the content of the
progress reports for the Design-Build Period and the Operation Service Period shall be as specified in the
Employer's Requirements" and later on, that "the particular reporting requirements during the Operation
Service Period shall be specified in the Employer's Requirements." The drafting is therefore ambiguous
as to whether the progress reports are to continue to be provided monthly during the Operation Service
Period or at some other frequency.

The Contract guide does not discuss frequency and so it would be prudent to ensure that the Employer's
Requirements specify the frequency of operational progress reports (as well as the content).

5. Design Obligations

Sub-clause 5.1 of the Gold Book states: "The Contractor undertakes that the designers shall be available
to attend discussions with the Employer's Representatives at all reasonable times". However when
applied to a 20 year operation period this could prove to be an onerous obligation.

Whilst the Contract Guide acknowledges that: "if the Employer's Requirements contain any immutable
provisions or require that any part of the design...be carried out by a third party... then the responsibility
for those provisions or parts must be clearly separated from the general responsibilities...However if
such third party is designated as a nominated designer (Nominated Subcontractor) then according to the
provisions of Sub-Clauses 4.4 [Subcontractors] and 4.5 [Nominated Subcontractors], responsibility for
the design will remain with the Contractor", it does not address the issue of when this obligation should
cease. A design team is never going to be available for the full 20 year Operation Service Period. A
better approach would be to clarify that obligation expires on the issue of the Commissioning Certificate.
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A further criticism of the design requirements is levelled against Sub-Clause 5.2, which relates to the
Contractor's Documents. It has been argued that there is undue complexity in distinguishing between
those Contractor's Documents that are open to inspection, from those submitted for review for "consent"
and those submitted for review "for approval". For example, for a document to be reviewed for approval
the Employer must: (i) describe in the Employer's Requirements that the document should be submitted
for review; and (ii) list the document as requiring approval in the Contract Data. Sub-Clause 5.3 provides
that should the Employer require further Contractor's Documents, they should be produced at the
Contractor's own cost. However, as these documents will not have been described in the Employers
Requirements as requiring review, and/or added to the Contract Data, presumably a variation would be
required for them to be subject to review and consent/approval.

The Contract Guide doesn't clarify matters; its only comment is: "As the [Contractor's Documents] form
such an important part of the work to be done by the Contractor, the Contract gives the Employer's
Representative and/or his Personnel, the right to inspect, review, comment upon and give consent to the
Contractor's Documents, and the Contractor is not permitted to proceed until such consent is given...
Any consent (or where specified, approval or review) shall not relieve the Contractor of any of his
responsibilities as to the correctness of such documents and his ultimate obligation that the Works be "fit
for purpose".

Of course, a broader question is whether adopting the Yellow Book approach to design review for a DBO
form is suitable at all and whether a more service-based approach, relying on the output specification,
would encourage more innovation from the Contractor. Whilst it is understandable that the Employer
would wish to approve certain Contractor's Documents (e.g. that relate to planning or similar high profile
consents that may be in the name of the Employer), given that the consent procedure (c.f. approval
procedure) does not act to transfer risk, one could argue that its inclusion in the design review
procedure therefore seems superfluous. Under the Gold Book, the Employer "gives his consent to a
document when he is satisfied that the Contractor's Documents conform to the Employer's
Requirements". As there is a requirement to pay the Employer's subsequent review costs should a
Contractor's Document be rejected following first review, a Contractor will be wary of providing
innovative designs for fear of the Employer rejecting them, especially where the Employer's
Requirements have not been drafted to allow for service based output requirements. Moreover, the
review procedure is designed for the Employer's control of the design, and to the extent that the
Employer wishes to review design documents, perhaps that should be at the Employer's cost; as the
Employer is best able to control such expenses.

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6. Value Engineering

Another factor influencing innovation is the Value Engineering provisions dealt with under Sub-Clause
13.2. Again, the DBO provision is essentially standard FIDIC (Yellow Book). The Contractor may submit
proposals at its own cost that may accelerate the Works, decrease costs, improve efficiency or
"otherwise benefit the Employer". It is questionable whether this will be utilised by the Contractor
considering that preparation of the proposal will be at the Contractor's cost and for the Employer's
benefit.

The Contract Guide tries to address this conundrum but by simply reiterating that "the benefits foreseen
by the Contractor must be benefits to the Works or to the Employer. Benefits to the Contractor in the
way of cheaper design or modified function are, by themselves, not enough". The Guide points out that
the Contractor will be financially motivated to perform value engineering because: "If there are savings
resulting from the value engineering, the share of this saving should be agreed prior to instructing the
variation. Alternatively, it is even better if the Special Provisions fix these proportions" so encouraging
the Parties to address this issue pre-contract.

7. Adjustments for Changes in Technology

With the pace of new technology, it is not surprising that the Gold Book (at Sub-clause 13.7) allows the
Employer's Representative to instruct the use of new technology, new materials or new products to be
used during the duration of the Contract. Of course, this incentive only works if there are actual financial
savings. The Contractor is entitled to an increase in time/cost during the design-build phase, and
increased costs during the Operation Service Period so no issue there, but a prudent Operator will
always want to consider the impact of such new technology/materials/products on the quality of the
operational service. Sub-Clause 13.1 only allows objection to the variation on the grounds that it "will
have an adverse effect on the provision of the Operations Service". That is not the same as "may have"
and so gives the Contractor very limited rights, especially where changes in technology during the design
phase may impact on the Operation Service Period (and so the actual impact will not be known at this
stage).

This issue is not addressed in the Contract Guide except to state "if the [Technology Change] occurs
during the Operation Service Period, the Contractor is entitled to receive financial compensation". A
prudent contractor should therefore consider including more detailed provisions protecting the
Contractor from changes in technology that could affect operational quality.
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8. Adjustments for Changes in Costs

Cost escalation over the 20 year operations period is addressed in the Gold Book under Sub-Clause 13.8,
which provides that "the Contract Price...Rates and Prices shall be adjusted in accordance with the
Schedules of cost indexation included in the Contract". There have been questions as to whether
indexation is the most appropriate mechanism to protect the Contractor from cost escalation or whether
periodic reviews (perhaps with occasional benchmarking against local market prices) are more
appropriate.

The Contract Guide is quite helpful here. It notes that it is normal "for a long-term DBO contract to
contain some provision for cost escalation, especially during the Operation Services Period" and goes on
to say that "the inclusion of a "hardship" clause may even be justified and appropriate during the
Operation Service Period given its long (20-year) duration. In such a clause, the Parties recognise that it
may be impracticable to make provision for every contingency which may arise, and state their intention
that the Contract shall operate between them with fairness and without prejudice to the interests of
either of them." It is a pity that the Guide did not go on to suggest particular drafting. Wording along
the lines of "fairness" or not so as to "prejudice to the interests of the parties" are likely to lack the
necessary certainty to be enforceable. Contractors should also ensure that the Schedules of indexation
are included as the Contract Guide makes it clear that there will be no mechanism for cost escalation if
they are not.

9. Operational Risk

As regards the allocation of risks during the Operation Service Period (Sub-Clauses 17.3 and 17.4), the
Gold Book does not allow for the effect of any Employer input into the operational services (say for
example the Employer is responsible for influent or control of waste materials in a wastewater treatment
or waste recycling plant). Whilst the Contractor is not responsible for delays/interruptions unless he has
caused them (sub-Clause 10.6), what about actual damage to the process? The Contract Guide does not
specifically address this. It simply says: "If a risk arises and the Parties cannot agree where the risk lies,
the matter will be decided by the Dispute Adjudication Board (DAB), and the risk will be carried or
shared by the Party or Parties named by the DAB" over which the Contractor has no control.

Sub-Clauses 10.6 and 10.7 of the Gold Book deal with delays to service during the Operation Service
Period and failure to reach output specifications. Whilst the Contractor is liable for all losses (including
loss of revenue, loss of profits and overhead losses) resulting from delays or interruptions during the
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operation period which are caused by the Contractor, such losses are hard to calculate and prove and
are subject to a liability cap. The Contractor is also liable for performance damages on failing to achieve
the production outputs and must take all steps necessary to restore the output to the required levels. If
underperformance continues for more than 84 days, the Employer may terminate the contract or make
reduced payments for the Service as calculated under the determination provisions. While providing
some recourse to the Employer, the loss/damage mechanism is unsophisticated compared to key
performance indicator/liquidated damages mechanisms provided for under contemporary DBO contracts.
Unfortunately the Contract Guide is silent on this point.

A further consideration is the use of insurance to spread the risk of operational failure. Despite the risk
allocation to the Contractor during the operations phase, business interruption insurance is not
mandatory under the Gold Book. It will benefit both Parties for such risks to be covered under business
continuity insurance where available, but a Contractor will have to consider carefully when including the
cost of such in its tender for fear of being under-bid. Further, as under Sub-Clause 10.9 ownership of
any output and revenues is the exclusive property of the Employer, does the Operator have an insurable
interest in the Employer's loss of revenue? The Contract Guide does address this issue stating that: "if
there are additional operational insurance which the Employer requires the Contractor to take out...the
Employer must make sure that such requirements are given in the Contract Data. Provided he does this,
the Contractor is responsible for including such requirements in prices...Examples of insurance cover
which might be required...are Machinery Breakdown, Loss of Profits and Loss of Profits following
Machinery Breakdown." Depending on the project, it may be beneficial for an Employer to require
insurance to protect against interruption during the Operation Service Period, but consideration should
be made as to the cost of renewing such insurance over the 20 year period. A mechanism where the
Employer shares in the burden of any increase in the premium above inflation would probably be the
best way to address such costs.

10. Contractor's Liability

One criticism of the Gold Book liability provisions (which largely mirror Yellow Book) are that they are
unclear when read alongside the new provisions dealing with operational liability in Sub-Clause 10.6.

Sub-clause 17.8 is a broad exclusion clause which, subject to certain express exceptions, excludes
liability for "loss of use of any Works, loss of profit, loss of contract or for any other indirect loss or
damage". However, one of the express exceptions to the 17.8 exclusion is Sub-Clause 17.9 which
provides for an indemnity from the Contractor to the Employer that arguably covers the majority of
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indirect losses that may be suffered by the Employer. Such is the extent of the indemnity under 17.9
that commentators have noted that the consequential loss exclusion under 17.8 may as well be solely to
the benefit of the Employer.

Commentators have also noted potential overlap between the indemnity under Sub-Clause 17.9 which
covers "all errors in the Contractor's design of the Works and other professional services which result in
the Works not being fit for purpose or result in any loss and/or damage for the Employer" and Sub-
Clause 10.6 where: "if there are any delays or interruptions during the Operation Service which are
caused by the Contractor or by a cause for which the Contractor is responsible, the Contractor shall
compensate the Employer for any losses including loss of revenue, loss of profits and overhead losses".
This is important as liability under 10.6 is subject to a determination (and most importantly, a liability
cap) while the indemnity under 17.9 is not.

Disappointingly, the Contract Guide doesnt specifically address these drafting issues although it says: "it
is very difficult for a Contractor to assess his risk exposure if he carries unlimited financial liability for the
consequences of certain events occurring" and so FIDIC does recognise that a Contractor would require
that it has a limit to its exposure to indirect risks.

11. Conclusion

The Contract Guide follows the traditional, narrow approach of such guides providing a commentary
summarising the provisions of the Gold Book and re-stating their intent. As such, it does address some
issues of interpretation and provides a more detailed explanation of the mechanisms that are used in the
form. Perhaps not surprisingly, the Contract Guide does not provide alternative clauses or wording to
address criticisms that have been levelled against certain provisions. These will need to be dealt with by
the parties themselves in the Particular Conditions/Special Provisions. There is a small section on
"Preparing Special Provisions" in the Guide but FIDIC make it clear that the reasons for change should
be limited to:
where the General Provisions indicate that alternate wording may be used (e.g. Commencement Date in Sub-Clause 8.1);
where the insurance provisions need to be changed;
where there are legal or other requirements not reflected in the General Conditions; or
if there are particular project features which render certain of the General Conditions inappropriate or unacceptable

Nor does the Guide widen the Gold Book's applicability to brownfield projects, a subject that we hope
FIDIC turns to next.