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The Grove Report was specially prepared at the request of the Government of the Hong Kong Special Administrative Region. The report involved reviewing and comparing the provisions of 12 major international construction contracts. The reviewer, Jesse B. Grove, III, then drew on the reviews, interviews with major players in the Hong Kong construction industry and his more than 30 years of experience as a construction lawyer to recommend changes in the Hong Kong Government's General Conditions of Contract for Construction Works. His report to the Government, which has become known as the Grove Report, sparked vigorous debate about the need to modify the contract.

The report, termed "controversial" by some, is the subject a two-day international conference on November 20 and 21, 2000, in Hong Kong. The conference is described as "An Agenda for Change in Response to the Grove Report – Two Days of Cutting Edge Debate."

	More Legal Reports on International Contracting
	Appendix A, Standard Documents Relevant to the Consultancy Study
	Appendix B, Treatment of Specific Risks Under Selected International Standard Forms of Contract
	Appendix C, Opinions of Other Experts
	Executive Summary (below)
	Introduction (below)
	Philosophies of Risk Allocation (below)
	General Assessment of the GCCs (below)
	General Recommendations (below)
	Consideration of Specific Issues Identified in the Brief (below)
	Financial Implications (below)
	Conclusion (below)
	Endnotes (below)

By Jesse B. Grove, III

This is the Final Report commissioned by the Government of the Hong Kong Special Administrative Region ("Government") by its Memorandum of Agreement with Jesse B. Grove, III ("Consultant"). It responds to the Consultant's Brief in Agreement No. CE 99/97, Review of General Conditions of Contract for Construction Works.

EXECUTIVE SUMMARY

After reviewing the General Conditions of Contract and related documents, performing extensive interviews with Government and industry representatives, studying international forms and practices, and applying his own experience, the Consultant makes the following general recommendations:

• Government should move away from the "independent engineer" concept toward express, reserved authority of the employer;
  
  
• Government should move away from the remeasurement delivery system in favor of fixed price contracts with schedules of rates for variation valuation only;
  
  
• Government should express and operate a preference for forward, lump sum pricing of variations;
  
  
• Government should make clear that breach of contract is subject to valuation and resolution in accordance with the contract terms;
  
  
• Government should introduce the right to terminate for convenience;
  
  
• Government should introduce the right to accelerate the works;
  
  
• "Catch-all" clauses should be avoided;

and the Consultant makes the following recommendations regarding the specific issues identified the Brief:

• Government should accept the risk of unforeseeable physical conditions;
  
  
• Government should not emasculate Clause 15 (the impossibility clause);
  
  
• Government should require All Risk insurance coverage;
  
  
• Government should accept the risk of lawful third party interferences, including utility undertakings;
  
  
• Government should accept the risk of changes in law;
  
  
• Government should let market forces operate regarding sub-contractor payment;
  
  
• Failure of notice should give rise to damages not forfeiture;
  
  
• Variation valuation should be simplified and tightened;
  
  
• Government should use dispute resolution advisers widely and make "no-decision" mediation "voluntary."

The Consultant justifies his recommendations on the ground that implementation of them will promote the public interest in receiving best value for money in the procurement of public works.

INTRODUCTION

1.1   The Hong Kong Works Bureau has a long history of periodic reviews and revisions of its conditions of contract for procurement of public works. 1/ Government has sought broad input from participants in the construction industry as part of the review and revision process. Since 1981, this has taken the form of a "Joint Discussion Group on the Standard Form of Conditions of Contract" including, besides Government officials, the Hong Kong Construction Association ("HKCA"), the Hong Kong Institution of Engineers ("HKIE") and the Association of Consulting Engineers of Hong Kong ("ACE"). 2/

1.2   The initial topics dealt with in the Joint Discussion Group included: consultancy agreements, time limits, mediation, arbitration, contractors' alternative designs, adverse sub-surface conditions, role of the Engineer and care of the Works insurance. Subsequently, additional topics were taken up, including: design/build, site safety, utilities, and immigration procedures for projects connected with the new airport. In 1990 a sub-committee of the Joint Discussion Group, the Utilities Working Group, was formed to consider the problems inherent in the existing utilities situation in Hong Kong.

1.3   There have been significant changes to Government's General Conditions of Contract ("GCCs") resulting from such collaboration. Some examples include the introduction of mediation (after a trial program), the improvement of arbitration procedures, the introduction of a trial program known as the "contractor's Method Statement" to address the sub-surface condition risk, the clarification of the role of the Engineer, and the introduction of a standard form for design/build. The Utilities Working Group has engaged in wide discussion of the problems concerning utilities, including a survey, and has issued an extensive First Working Paper.

1.4   Within Government, another group, consisting of representatives from the various departments of Government who engage in public works, the Department of Justice and the Works Bureau, has been working in parallel through the Committee on Review of the GCCs. This Committee has taken up the issues arising from the Joint Discussion Group and the Utilities Working Group, and also other areas of improvement of the GCCs.

1.5   In the course of these discussions and considerations, it was deemed useful to seek advice from a consultant who could provide the perspective of "best international practice" free from any bias that might arise from personal involvement with Hong Kong public works.

2.   The Consultant's Brief

2.1   The Consultant was engaged to make a "fundamental review of the GCCs and in particular the allocation and management of risk in the procurement of works projects... with recommendations on any modifications necessary in the interests of public finance based on international best practice."

2.2   The objective of the engagement was "to enable the employer to make policy decisions on specific issues, and to facilitate a revision of the procurement procedures and the GCCs, if necessary."

2.3   In the course of reviewing and advising on management and allocation of risk, the Consultant was asked to consider the following particular areas of the GCCs:

• ground conditions (Clause 13)
  
  
• physical impossibility (Clause 15)
  
  
• care of the works (Clause 21)
  
  
• delay caused by public utility works (Clauses 50 (1)(b)(ix) and 63 (d))
  
  
• fees and charges, new legislation, etc. (Clauses 29, 30)
  
  
• payments to sub-contractors (Clause 69) and
  
  
• time bar provisions in respect of claims (Clauses 50 (1) and 64).
  
  

2.4   The Consultant was additionally asked to advise and recommend changes to the GCCs, where appropriate, in respect of:

• valuation of variations and financial losses with regard to disturbance to the progress of Works (Clauses 59-64),
  
  
• prolonged process in the settlement of claims and disputes, and
  
  
• mechanisms for the acceptance of an alternative design proposed by the contractor after the award of the contract.

2.5   I was officially engaged as the Consultant on 15 March, 1998.

3.   The Consultant's Work Programme

3.1   Pursuant to the requirements of the Brief and the Programme approved by the Director's Representative 3/ on behalf of the Director 4/,I first reviewed Government's standard documents 5/ as identified and furnished by the Director's Representative.

3.2   I then engaged in introductory meetings in Hong Kong with the Acting Secretary for Works; the Director's representative; representatives of Government Departments 6/, the Department of Justice and the Treasury; and representatives from industry groups, including the HKCA, the HKIE, the ACE, the Hong Kong E&M Contractors' Association, the Hong Kong Institute of Architects, and the Hong Kong Institute of Surveyors. Further and more extensive meetings with these and other representatives of Government and industry were held during two follow-on visits to Hong Kong. During these sessions, I was frequently given statements of position and background materials to consider.

3.3   From meetings and study of their general conditions of contract, I was able to compare the practices of the Airport Authority and the Mass Transit Railway Corporation to those of Government.

3.4   Additionally, I received useful information and advice from solicitors Dean Lewis of Masons, Phillip Nunn of Simmons & Simmons, and Ernest Kwok of Kwok & Chu; Professor Mohan Kumaraswamy of Hong Kong University; mediator Colin Wall of Commercial, Mediation & Arbitration Services, Ltd.; arbitrator Neil Kaplan of the Hong Kong International Arbitration Centre; and quantity surveyor Dennis Levett of Levett & Bailey.

3.5   For purposes of satisfying the mandate of the Brief that any recommended modifications in the allocation and management of risk be congruent with international best practice, I have referred to standard forms of contract that are used internationally and my own experience. The standard forms are:

• Fédération Internationale des Ingénieurs-Conseils (International Federation of Consulting Engineers or FIDIC), Conditions of Contract for Works of Civil Engineering Construction, Part I, General Conditions, Fourth Edition (1987, reprinted in 1988 and 1992 with amendments); 7/
  
  
• Australian Standard, AS 4000--1997, General Conditions of Contract (1997);
  
  
• The Institution of Civil Engineers (United Kingdom), The Engineering and Construction Contract, Second Edition (1995, reprinted with corrections May, 1998) ("ECC," formerly the "NEC");
  
  
• Federal Acquisition Regulation (United States), Title 48, Subpart 52.2, Code of Federal Regulations, Text of Provisions and Clauses (1997);
  
  
• American Institute of Architects (United States), AIA Document A201-1997, General Conditions of Contract for Construction (1997);
  
  
• Engineering Advancement Association of Japan (Japan), ENAA Model Form International Contract for Power Plant Construction (Turnkey Lumpsum Basis),Vol. I, General Conditions (1996);
  
  
• Construction Industry Development Board (Singapore), Public Sector Standard Conditions of Contract for Construction Works (1995);
  
  
• GC/Works/1 Without Quantities, Contract for Building and Civil Engineering Major Works, General Conditions (England, 1998) ("GC/Works/1");
  
  
• The World Bank, Standard Bidding Documents, Procurement of Works (1995) ("World Bank"); 8/
  
  
• Joint Contracts Tribunal for the Standard Form of Building Contract (United States), Standard Form of Building Contract, Private With Quantities (1980 Edition, incorporating Amendments issued through April, 1998) ("JCT 80");
  
  
• Joint Contracts Tribunal for the Standard Form of Building Contract (United States), Standard Form of Building Contract With Contractor's Design (1981 Edition, incorporating Amendments issued through April 1998) ("JCT 81"); and
  
  
• Institution of Civil Engineers, Association of Consulting Engineers and Federation of Civil Engineering Contractors, ICE Conditions of Contract (Sixth Edition, January 1991; reprinted with amendments, November 1995; reprinted November 1997) ("ICE 6th Edition").

There are, of course, other forms that could be considered, but the foregoing are thought by me to be representative of international, if not always best, practice. A matrix has been prepared showing the choices made in the above forms with respect to the issues called out in the Brief. 9/

PHILOSOPHIES OF RISK ALLOCATION

4.   In General

4.1   All construction contracts allocate risks, and there are some basic philosophical choices to be made. The most basic of all is to choose who takes the default position. At common law the contractor has all risk that is not specifically accepted by the employer. This was eventually the approach taken in the ECC although the NEC attempted to define all risks to be borne by each party. The American Institute of Architects takes the view that all risks belong to the employer when no other party can either control the risks or prevent the loss. The Government of the U.S.A. has long held to this view. I submit that this ideological issue does not much matter when sophisticated forms of contract are in use because unallocated risks so rarely arise, but there is a considerable body of thought that when "wild card" risks do occur they are best borne by the party who gains the long-term benefit of the project, namely the employer.

4.2   An overlay on the whole subject of risk allocation is that insurers should take the risk when they are willing to do so at reasonable cost. Of course, it is the employer who pays the premium for the insurance (regardless of who must obtain it) so this should be seen as allocating risk to the employer. That is a correct view, but it is also correct that insurable risks are borne by society at large through the insurance mechanism of risk spreading. Since insurable risks are by definition fortuitous, that is, not the fault nor under the control of the insured, there is no obvious basis for allocation to the contractor.

4.3   The choice of construction delivery system is partly an exercise in risk allocation because the accompanying payment schemes (e.g., cost reimbursement, remeasurement, lump sum) operate to place the cost of risk materialization on one party or the other in the absence of specific contrary provision. 10/ This choice does not require extended consideration here because Government's need to protect and manage the public fisc militates against open-ended payment schemes except in the most unusual of circumstances. The usual choice for Government is between lump sum and design/build with the latter having the advantage of the contractor bearing the risks of design error and designer delay in circumstances not rising to the level of professional malpractice (the risk of malpractice falls on the designer either way). Arguably it is appropriate for the contractor to accept the ground condition risk in design/build work if the opportunity to investigate and design for adverse conditions is adequately allowed.

4.4   It is always possible to share risks. Mechanisms for this include percentage sharing of overruns 11/, awarding time but not money 12/, limiting the types of costs that can be recovered, setting liquidated damages rates lower than justifiable, and using liability caps. But I am unable to discern any logical basis for the sharing solution except to give both parties incentive to avoid and mitigate the risk. Since I consider that both parties are adequately motivated already, the sharing solution has no appeal other than the spirit of compromise.

4.5   The ultimate goal of optimal risk allocation is to promote project implementation on time and on budget without sacrifice in quality, that is, to obtain the greatest value for money. The goal for a repeat employer should be to minimise the total cost of risk on a project, not necessarily the cost of either party. A study in the U.S.A. has shown that 5 percent of project cost may be saved by choice of the most appropriate terms of contract alone. 13/ The question is therefore what is "most appropriate" and how can it be recognized? There are a variety of answers.

5.   The Fault Standard

5.1   Perhaps it goes without saying that the cost and time impacts of risks caused (or not avoided) through the fault of a party should be borne by that party. This unexceptional concept runs through all construction contracts that I have encountered. It is mentioned here only because some provisions of the GCCs run directly counter to this basic rule.

6.   The Foreseeability Standard

6.1   The UK ICE determined in the early 1970s that "the contractor should only price for those risks which an experienced contractor could reasonably be expected to foresee at the time of tender." This theme appears throughout the ICE forms (and to some degree in all of the forms identified in paragraph 3.5). Although not of obvious value to employers, this is a useful concept as far as it goes. Unfortunately, it does not go far enough to provide a satisfactory guide for allocation of risks that are (i) foreseeable in general but not in specific terms, (ii) unforeseeable but (at least partly) preventable, or (iii) unforeseeable but insurable.

6.2   The usual rationale for this standard is that employers will pay for unmaterialized risk if contractors are forced to include contingency sums in tenders to hedge against that which is unforeseeable. This rationale may apply in some circumstances, but I believe that the traditionally stiff competitive conditions in the construction industry coerce contractors away from adding contingencies except for large civil projects. The real disadvantage to the employer of forcing the risk of the unforeseeable on the contractor is that contractors who are gamblers and claims artists will predominate among the winners of contract awards.

6.3   The foreseeability concept is subject to fair criticism on the ground that uncertainty is introduced. What is the baseline of deemed knowledge? What is the base date? What is the definition of "reasonable contractor" (at least we know the novice will be judged by the rules applicable to old hands)? What is the dividing line when the risk is foreseeable in general but not to the actual degree of severity? There are no pat answers. These are areas that require judgment applied to unique circumstances. Consequently there will be room for disputation. On this ground the foreseeability standard is perhaps only useful when no other rule makes sense.

7.   The Management Standard

7.1   This philosophy holds that risk belongs to the party who is best able to evaluate and control it, i.e., to manage it, because that party will do the best job of minimizing both the occurrence and severity of the risk for the good of all parties to the process. This too is useful to some extent, but ought to be modified at least by also giving consideration to a party's ability to bear the risk. A crushing risk materialization is not manageable.

7.2   The proponents of the management standard do not explain the rationale for allocating risks that neither party can evaluate and control, such as acts of God and third parties, nor do they admit that allocation according to ability to manage may be inconsistent with well-developed notions of fundamental fairness. Consequently, it is easy to overstate the applicability of the standard.

7.3   One must also realize that it is mostly the employer who can reduce risks through pre-construction planning, exploration and design effort while it is mostly the contractor who can mitigate the effect of an occurred risk during construction. If a risk, such as ground conditions, is subject to both pre- and post-construction mitigation, the management standard provides no obvious allocation rule.

8.   The Incentive Standard

8.1   The NEC is said to have introduced a variant of the management standard which might be called the philosophy of incentive. The postulate is that risks should be placed on the party most in need of incentive (presumably already with the ability) to prevent and control them. This is thought to motivate people to play their part. An examination of the "compensation events" listed in the ECC does not, however, demonstrate that this philosophy has been uniformly applied.

8.2   While I do not quarrel with the spirit of this philosophy, I think it based on a misapprehension of real world conditions. Contractors and employers are highly motivated to avoid and mitigate risk materialization already. Both parties lose when a project is impacted by cost and time overruns regardless of risk allocations. One may lose more than the other, but both lose and everyone knows it.

9.   Application of Philosophy

9.1   It is not enough to say that there should be a "balance of risk" or "efficiency in risk allocation" because all of us will never agree on what is a fair and reasonable balance between the contractor and the employer or which terms are most efficient for either of them.

9.2   When studying the views of the proponents of, and commentators on, the various philosophies of risk allocation, one is tempted to conclude that the same principles underlie them all. Certainly there seem to be the following common considerations:

• Which party can best control the events that may lead to the risk occurring?
  
  
• Which party can best manage the risk if it occurs?
  
  
• Whether or not it is preferable for the employer to retain an involvement in the management of the risk.
  
  
• Which party should carry the risk if it cannot be controlled?
  
  
• Whether the premium charged by the transferee is likely to be reasonable and acceptable.
  
  
• Whether the transferee is likely to be able to sustain the consequences if the risk occurs.
  
  
• Whether, if the risk is transferred, it leads to the possibility of risks of different nature being transferred back to the employer. 14/

If these considerations are applied, it should be possible to achieve clear and realistic terms that are acceptable to the employer and on which contractors are prepared to tender at prices which do not contain contingencies for unclear terms or for significant risks which are not possible to estimate with some certainty or which are unlikely to materialize.

9.3   In my opinion, Max Abrahamson has come the closest to laying down an acceptable "formula" for risk allocation, as follows:

[A] party should bear a construction risk where:

1.  It is in his control, i.e., if it comes about it will be due to willful misconduct or lack of reasonable efficiency or care; or

2.  He can transfer the risk by insurance and allow for the premium in settling his charges to the other party... and it is most economically beneficial and practicable for the risk to be dealt with in that way; or

3.  The preponderant economic benefit of running the risk accrues to him; or

4.  To place the risk on him is in the interests of efficiency (which includes planning, incentive, innovation) and the long term health of the construction industry on which that depends; or

5.  If the risk eventuates, the loss falls on him in the first instance, and it is not practicable or there is no reason under the above four principles to cause expense and uncertainty, and possibly make mistakes in trying to transfer the loss to another.

The job of trying to balance the five principles in practice is the hard one.... But at least it is best to work from declared principles rather than undeclared and perhaps unconscious prejudices. 15/

With this as my frame of reference, I now turn to an assessment of the GCCs.

GENERAL ASSESSMENT OF THE GCCs

10.   In Broad Terms

10.1   The GCCs evolved from the ICE forms that preceded the Sixth Edition. As such, they represent, in broad terms, a fairly sophisticated and extensive set of general conditions, acceptable internationally and congruent with risk allocation practice followed in other international forms with exceptions hereafter noted. I would describe the risk allocation scheme as basically very fair.

10.2   In many respects the GCCs have already been modernized, and this is to be commended. The modernizations include:

• Separating the dispute resolution function from the design function 16/ and providing for independent, de novo review of Engineer's decisions;
  
  
• Moving away from the practice of nominating subcontractors; and
  
  
• Experimentation with and adoption of alternative dispute resolution procedures, and modern arbitration rules.

These are consistent with the trends in international practice. 17/

10.3   The risk allocation choices in the GCCs are unexceptional except as hereafter discussed. Numerous risk management provisions (notice 18/, contemporaneous records and site diary, particulars, valuation procedures, etc.) are likewise appropriate except as hereafter noted.

10.4   The language and phrasing of the GCCs could be criticized as archaic and unduly stylized. For example, the clauses relied upon to provide contractor entitlements often do so negatively by means of exception to disentitlement. The benefit of staying with this language is that industry participants have come to know its meaning through years of operating the clauses. There will eventually be a need to simplify and clarify the language, but I do not believe that this is important at this time.

GENERAL RECOMMENDATIONS

11.1   Move away from the "independent engineer" concept toward express, reserved authority of Government. The basic problem with the "independent engineer" concept is that the Engineer can never be seen as truly impartial because he is paid by the employer and he is naturally disinclined to find fault with his own design. While employers need (and should normally heed) unbiased professional and technical advice from consultants, there is no reason for a sophisticated employer such as Government to cede control over commercial and contractual matters to an independent party. The project after all belongs to and is paid for by Government. This should bring with it the prerogative of control over voluntary concession of extra time or money to the contractor. The contractor has fully adequate opportunity to dispute and contest Government's decisions through the truly impartial dispute resolution procedures in the GCCs. If the Engineer no longer has the decision-making function, the assertion of the HKIS that independent (of the Engineer) quantity surveyors should be assigned the role of determining contractual and commercial issues on civil works becomes academic. Their premise -- promotion of the appearance of impartiality -- simply does not matter if the role is advisory. The advisory role should go to the consultant who is most qualified professionally. That could be a quantity surveyor (who has no reason to defend design deficiencies), but engineers also possess contractual and commercial sophistication and perhaps more experience in resolving civil works issues, especially technical ones.

11.2   Move away from the remeasurement delivery system in favor of fixed price contracts with schedules of rates for variation valuation only. 19/ The remeasurement system places the risk of quantity variation on the employer and detracts from Government's ability to predict the outturn construction cost of a project. Contractors are prepared to accept this risk because quantities are normally well within their ability to estimate with reasonable certainty. Indeed, it is rare that a contractor will suffer a cost overrun through misapprehension of quantities. Labor cost (i.e., productivity) is far more difficult to estimate and far more frequently the cause of financial disappointment. Consequently contractors do not need and Government need not grant risk protection here. The exception to this generality is, of course, where unforeseen adverse ground conditions are encountered. If contractors must bear the ground condition risk, then remeasurement is a way of reducing the burden, albeit haphazardly. It is far preferable to address the ground condition issue directly (as hereinafter recommended). Absent the ground condition consideration, fixed price contracting serves Government's legitimate need for accountability and prudent fiscal management through increased certainty of projected construction cost, and does no disservice to contractors. This does not mean that there is no longer any place for schedules of rates. The use of such schedules for variation valuation can greatly simplify that process and commensurably reduce the possibility of disputation. Government must, however, retain the right to reject quoted rates if they are perceived to be excessive.

11.3   Introduce breach of contract as an event to be valued and resolved under the contract terms. The current form of GCCs does not explicitly deal with employer breach of contract except that Clause 86 enables the Engineer to decide "any dispute or difference of any kind whatsoever." This leaves open the possibility that the contractor might have a breach claim at law independently of his contractual entitlements which are circumscribed and subject to determination by specified alternative dispute resolution procedures. Arbitrators and mediators may be unsure of their ground here. The solution is to make breach of contract by the employer just another entitlement event under the contract. 20/

11.4   Introduce the right of Government to terminate for convenience. In highly unusual circumstances, Government may wish to terminate ("re-enter") the contract for reasons unrelated to contractor default. 21/ In order to avoid a claim for lost profits from the contractor, it is useful to have this right spelled out and to limit the contractor's entitlement to that which is commensurate with work performed. A side benefit is that the termination for default clause may be modified to provide that wrongful termination by the employer shall be treated as a termination for convenience.

11.5   Introduce the right of Government to accelerate the works. If the works are not on schedule for reasons that are not the fault of the contractor, the employer may nonetheless wish to have use of the project prior to the contractual (substantial) completion date as it may have been revised by extensions of time. There should be an express right for the employer to order acceleration of the work so long as the contractor is appropriately compensated. 22/ Provided that the acceleration order is reasonable, there is no reason to suppose that the enforceability of liquidated damages will be affected.

11.6   Avoid catch-all clauses. Clause 50 (relating to time extensions) contains a catch-all clause: "any special circumstance of any kind whatsoever". This is an invitation to stretch ingenuity, and the results are unpredictable. This is not to say that supplemental agreements should not be based on special circumstances, only that such ambiguities do not belong in the contract itself. 23/

11.7   Require escrow of estimating files. The successful tenderer should be required to escrow his full working file showing take-offs and pricing supporting the tender. The escrow would be opened only in case of dispute requiring arbitration. A contractor's estimating files will contain a world of information about what was foreseen and how risks were priced. It will also reveal whether a contractor's ultimate losses on a project were caused by inaccurate estimating as opposed to subsequent events. Full access to the estimating files will, in most cases, lead to settlement of disputes. Therefore, I recommend requiring contractors to escrow their estimating files upon receipt of contract award. The escrow would not opened except in the event of a contractor claim for extras that remains unresolved for a certain period of time.

11.8   Use liquidated damages wherever possible. This device avoids difficulties in administration of the contract and reduces the possibility of dispute. Liquidated damages already are used routinely for delay damages, but the concept is equally applicable to damages for performance deficiencies of the type that are (i) measurable by units and (ii) excessively costly to make good. Some examples might include slight failures of large equipment (say pumps, chillers or turbines) to perform at the ratings specified.

11.9   Comparison to International Practice. The above recommendations are consistent with best international practice (although certainly not universally practiced) with the exception of requiring escrow of estimating files. That requirement does not appear in any of the forms identified in paragraph 3.5, and to my knowledge it has only rarely been used. While I think there are many benefits and no legitimate objections to the practice, Government should expect heavy resistance from the contracting community on this point.

CONSIDERATION OF SPECIFIC ISSUES IDENTIFIED IN THE BRIEF

12.   GROUND CONDITIONS

Assessment

12.1   Clause 13 24/ of the GCCs places the risk of unforeseen and unforeseeable sub-surface conditions (and other risks) on the contractor regardless of whether the contractor was misled by insufficient or inaccurate information given him by Government. 25/ Thus, the contractor must bear the financial consequences (including liquidated damages for consequent delay) of discovering the unexpected, whether it be natural (e.g., faulting, fracturing, quicksand vice rock, rock vice soil, voids, material prone to settlement, peaks and valleys in rock profile), toxic or hazardous (e.g., military ordnance, asbestos, hydrocarbons, PCBs, industrial and human wastes), or manmade (e.g., utilities, pilings, artifacts, antiquities, out-of-specification embedments in reclamation areas).

12.2   Contractors regard this provision of the GCCs as the most repugnant of all. The risk materializes frequently in the form of utility clashes but in that form often is mitigated through variation of the works, which attracts contractor compensation, thereby reallocating the risk to Government. In its other forms, it is to be feared as a risk that cannot be foreseen or, if foreseen, evaluated through estimating, and because it is potentially catastrophic. Fortunately, the risk in its other forms is unlikely to materialize on most public works projects (which implies that neither party should be concerned about bearing it), but it arises often enough (usually on civil or building foundation works) that it must be considered an important risk allocation issue.

International Practice

12.3   The risk of unforeseeable physical (usually sub-surface) conditions is almost always borne by the employer in international practice. Every one of the contract forms listed in paragraph 3.5 so provides. I have only been able to identify one other country, Malaysia, in which this risk is allocated to the contractor. Clause 13 is right against international practice.

Recommendation

12.4   Government should accept the risk of unforeseeable physical conditions. This recommendation means compensating the contractor and extending time for performance if physical conditions are encountered which were not foreseen and which (i) are different from those set forth in the tender documents or (ii) could not have been foreseen by an experienced contractor acting reasonably in the preparation of the tender.

Justification of Recommendation

12.5   The most important way to deal with this risk is to eliminate it through pre-tender sub-surface and site explorations, and designs that allow for suspected adverse conditions. I understand from interviews that Government's designers are up to the mark in this area. The fact remains that there will always be some risk of unexpected adverse physical conditions despite highly professional design efforts having been applied. If the conditions should have been appreciated but were not because of professional error or if the design is unreasonably aggressive, the risk will accrue to the designer (or design/builder).

12.6   The second most important mitigator is to make sure the tendering contractors have adequate opportunity to make a visual inspection of the site and consider all available geological and exploratory information. This means that Government should take the initiative to gather such information and give it to the contractors with explicit warnings of indicators of difficult conditions. Contractors may be required to make their own interpretations, but that is not a basis for withholding interpretations by Government's experts. Since a well-drafted clause will prevent entitlement to extra compensation in connection with conditions actually foreseen, it is important to give the contractor every opportunity to foresee.

12.7   It may occur that the contractor is misled by justifiable reliance on insufficient or inaccurate information supplied by Government. If this occurs by reason of professional negligence, the risk will fall on the designer. In any event, the risk should not fall on the contractor. The first principle of risk allocation -- the Fault Standard -- applies. It is unconscionable for Government to transfer the risk of its own misrepresentation, and possibly not enforceable at law. It should be noted that accepting responsibility for representations made as to physical conditions brings with it an alternative risk sharing mechanism. Where Government wishes the contractor to bear risk up to a certain level (e.g., one foot of soil settlement) but is willing to accept the risk that conditions will turn out to be worse, it can achieve this by representing that conditions will be no worse than the specified level.

12.8   The risk that a truly unforeseeable and unforeseen physical condition will be encountered remains to be considered. Those who adhere to the Foreseeability Standard (which includes the majority of international employers) have no difficulty concluding that this risk should not be transferred to the contractor. Those who prefer the Management Standard argue that this risk belongs to the employer because the employer has the best opportunity to control and avoid the risk through pre-tender site exploration. (It cannot seriously be argued that the contractor has similar opportunity, and anyway employers do not want multiple tenderers performing site explorations for a whole host of practical reasons.) The Incentive Standard can be argued either way, but it is noted that this is an employer's risk under the ECC.

12.9   A compelling consideration is that this risk has potentially catastrophic consequences beyond that which even a large international contractor can bear. Thus a contractor who has accepted the risk may have no alternative to an attempt to pass it back to the employer through some stratagem such as a strained theory of impossibility.

12.10   The risk is also impossible to quantify by estimate and allow for in pricing. This means that contractors will either throw a "guesstimate" contingency into the tender price or take a gamble that all will be well. The effect is that the winning tenderer will either be the gambler or the low guesser. Frequently this will be the thinly financed, low asset contractor who has little to lose. It is not in Government's interest to attract this calibre of contractor, nor to discourage highly competent, conservative contractors.

12.11   On a practical level, contractors refuse to accept that this risk should be borne by them. If forced to accept the risk, they will strive mightily to offset the burden. Excessive claimsmanship and adversarial conduct can be expected. This creates the breeding ground for disputation and its notorious consumption of resources.

12.12   Another reason for changing Clause 13 is that it is difficult for the employer to administer, and it is probably being administered inconsistently. When an unforeseen physical condition -- say, an utility clash -- is encountered, Government has two choices: leave the solution up to the contractor or issue a variation order to overcome the difficulty. The former leaves the financial burden on the contractor, and the latter transfers it to Government. Government's representative is thus motivated not vary the works even if that is (i) the most desirable or cheapest solution or (ii) the best technical solution. This could even lead to a viable contractor claim of impossibility notwithstanding that a minor specification variation would obviate the problem.

13. LEGAL AND PHYSICAL IMPOSSIBILITY

Assessment

13.1   Clause 15 has a proviso ("Save in so far as it is legally or physically impossible...") that is interpreted to mean that the contractor is excused from performance if strict compliance with the terms of the Contract is impossible. Presumably the contractor is entitled to breach of contract damages if forced to struggle against the impossibility and payment, perhaps on a quantum meruit basis, for work accomplished prior to the impossibility of continuing, although at common law the loss would lie where it falls. Commercial impracticability may be seen as the equivalent of impossibility for this purpose. There have been a number of recent instances of contractor claims of impossibility in connection with Hong Kong public works projects.

13.2   The recent onslaught of impossibility claims indicates that either the GCCs are "misfiring" in practice or the designs for public works have become much too aggressive. There is a root cause to be discovered and addressed. The fault does not lie in Clause 15 or the impossibility concept itself.

International Practice

13.3   This clause arises from (and negates) the English legal concept that a party may be bound by his agreement to do the impossible. Similar clauses are found in other contracts of English derivation, but not in U.S.A. forms. It is likely that all jurisdictions will recognize in some fashion that a contractor should be relieved of the obligation to perform that which is absolutely impossible to perform. 26/ The question whether commercial impracticability rises to the level of impossibility (and the definition of it) is likely to draw varying responses depending on the local legal system and current state of the art. 27/ Contractor claims of impossibility are rare in my own experience and certainly not as prevalent as recently seen in Hong Kong. Intuitively it would seem that such a claim would only be necessary in extreme circumstances calling for desperation measures.

Recommendation

13.4   Do not emasculate Clause 15. The problem does not lie in the clause.

Justification of Recommendation

13.5   One way to change Clause 15 is to eliminate the idea that the contractor should be relieved of his performance obligation if performance is impossible. There is no justification for such an onerous position which would be right against international practice and possibly unenforceable.

13.6   Another possible change would be to define impossibility so as to exclude commercial impracticability or at least mild forms of same. This is unwise because commercial impracticability is in fact tantamount to impossibility at least in its extreme form, and it would be very difficult and counter to the goal of avoiding disputation to attempt to draw a line between "mild" and "extreme."

13.7   Anyway, I do not consider that Government has much to fear from impossibility claims if the GCCs are operating effectively and fairly. In cases of true impossibility the problem can be dealt with by variation order or by termination for convenience without untoward financial detriment to Government. Tenuous impossibility claims should not ordinarily arise because of the high risk, all or nothing nature of the claim. This sort of claim is a desperation measure for a contractor, and desperation circumstances should not ordinarily exist. The fact that impossibility claims are now being seen more frequently can be partly attributed to inappropriate risk allocations in the current GCCs.

13.8   There is an interpretation issue related to Clause 15 that is troublesome. It is open to argument that impossibility of strict contractual compliance must be assessed as of the date of contracting. From that it would follow that the contractor is entitled to relief (excuse from performance or damages to compensate for struggling to perform) notwithstanding that the contractor could devise an extra-contractual solution -- or the employer could issue or even had issued a relaxation of contract requirements or a variation order -- that entirely eliminates the impossibility. There is no commercial or technical logic for such an artificial result. Moreover, the possibility might encourage undue claimsmanship. It makes more sense to compensate the contractor for the cost of the struggle and for seeking and recommending a reasonable solution to the problem even if that would involve modification of, for example, the specifications. Relief from performance should not apply where a solution exists. Although I am normally averse to tinkering with contract clauses, I recommend that Government revise Clause 15 so as to avoid this interpretation issue.

14. CARE OF THE WORKS

Assessment

14.1   Clause 21 places full responsibility on the contractor for care of the works during construction except damage, loss or injury arising from occurrence of an "excepted risk."

International Practice

14.2   This requirement is consistent with international best practice.

Recommendation

14.3   Require All Risk insurance coverage. This should be made explicit in the GCCs.

Justification of Recommendation

14.4   All Risk insurance coverage against loss to the works arising from fortuitous perils is readily available at reasonable premiums. It is a bright line rule of risk allocation that risks should be insured in such circumstances. Additionally, this protects Government against contractor inability to make good on injury to the works from its own capitalization.

15. THIRD PARTY INTERFERENCES

Assessment

15.1   Utilities 28/ are required by law to place new installations and relocate old ones as necessary to accommodate public works projects at the cost of the utility. In practice, it is deemed the responsibility of the contractor to determine what is in place and to make arrangements with the appropriate utility for performance of the undertaking. Clause 63 (d), by exception, disallows payment to the contractor for unreimbursed expenditures caused by disturbances to the progress of the works by an utility undertaking. 29/ Clause 50 (1)(b)(ix) allows an extension of time if the utility fails to perform "in due time" so long as the contractor has taken all practicable steps to cause the utility to do so. Thus, the contractor must bear the financial consequences (excepting liquidated damages for consequent delay) when an utility fails to pursue planned locations and relocations with due diligence. The First Working Paper of the Utilities Working Group cites numerous examples of this type of occurrence working financial harm on contractors.

15.2   This provision of the GCCs is also highly controversial. The risk materializes frequently because (i) Hong Kong utility lines are everywhere and (ii) Hong Kong utilities rarely meet contractors' expectations and desires for prompt undertakings (regardless of fault by the utility or unrealism by the contractor). The consequences of this risk materializing should never be catastrophic although likely sufficient to eliminate the opportunity to earn profit on a project.

International Practice

15.3   In international practice disturbance costs associated with third party delays are compensable to the contractor if arising from discovery of unforeseen physical conditions. If not, there is no settled international practice, although time extension is usually provided for by a force majeure clause, and cost recovery would normally follow from the employer's effective failure to provide the site (it being lawfully occupied by the third party).

Recommendation

15.4   Government should accept the risk of lawful third party interferences, including utility undertakings. This recommendation means compensating the contractor for extra costs caused by events beyond the contractor's control such as tardy utility undertakings.

Justification of Recommendation

15.5   If the risk materializes through the act of a Department of Government, then the Fault Standard mandates that Government bear the consequences. If the risk materializes in connection with an unforeseeable sub-surface condition, my preceding recommendation, if accepted, would provide compensation and time to the contractor. If the risk materializes through unlawful conduct by a third party, the contractor should look to that party for his remedy. It is where the risk materializes through lawful, albeit disruptive, conduct by a third party -- usually an utility -- that the allocation criteria must be applied.

15.6   This risk is foreseeable in general, but not in particular, and it is hard to quantify by estimate. The occurrence and severity of the risk are not very much under the control of either party absent legislative change although both parties can urge the utility to act responsibly. Thus, the usual standards for risk allocation do not yield a clear answer.

15.7   I justify this recommendation on the ground that public utility work is sufficiently analogous to work by the Government itself that the consequences of interference arising therefrom should be borne by the public through Government acceptance of the risk. It could be argued that only that part of the public which is directly served by the particular utility should bear the risk, but I consider that a minor objection to the general principle and anyway impossible to achieve without legislative change.

15.8   If this recommendation is accepted, there should be some accompanying risk management provisions. It would be useful to establish an entitlement baseline by stating in the tender documents the amount of time that the tenderer should allow in his programme for utility relocations. The Employer should have the right to take control of relations with the utility if the contractor exhibits a laissez faire attitude.

15.9   It may be possible for Government to arrange with the utilities for the contractor to perform relocation work at the utility's expense more widely than currently done. If the work is specialty work, the contractor could retain a specialist sub-contractor. This would seem to be worthwhile for the Utilities Working Group to continue exploring.

16.  CHANGES IN LAW

Assessment

16.1   Clause 30 places the risk of changes in law (and regulations having the force of law) on the contractor, and Clause 29 places the contractor at risk of unanticipated legal imposition of licenses, levies, premiums or other fees by duly constituted authorities. Consequently, contractors are required to pay unanticipated fees and charges from time to time. More importantly, contractors are exposed to perhaps drastic changes in the cost of performing work if environmental, safety or labor laws are significantly changed. A recent example was a change of law affecting worker's compensation insurance rates.

16.2   Evolution of environmental, labor and safety laws affecting contractors' costs of performance is inevitable. Any changes that are significant are also, however, likely to be heavily debated over a protracted period, which will provide warning well in advance.

International Practice

16.3   Most forms of contract in international use explicitly provide relief to the contractor if the costs or time of performance are increased by changes of law. Clause 30 is right against international practice.

Recommendation

16.4   Government should accept the risk of changes in law. This recommendation means compensating the contractor and extending time for performance for additional costs and delay caused by change in law.

Justification of Recommendation

16.5   This risk is unrelated to fault unless a broad definition of "Government" is adopted such that Departments engaged in public works are deemed one and the same as the legislative authority. It is likewise beyond the control of both the contractor and Government procurement departments. Neither can benefit from extra motivation in this area. Because the proposed change will have been publicly mooted (or even gazetted) prior to tender, it is foreseeable in kind, but unforeseeability of timing and full effect may make it difficult to estimate.

16.6   This recommendation can be justified on grounds of fundamental fairness, which is what Abrahamson is getting at in his fourth principle. I think, however, that the true justification lies in the fact that the employer stands to gain the long term benefit of the project and is thus better able to absorb (spread, amortize) the cost of a rule change than is a contractor, who has competed for a comparatively short term engagement on the basis of the rules extant.

17. SUB-CONTRACTOR RELATIONS

Assessment

17.1   There is nothing in the GCCs that requires Government to intervene in payment disputes between contractors and sub-contractors although Clause 69 mandates prompt contractor payment of Nominated Sub-contractors 30/ failing which Government is entitled to make direct payment. Consequently, sub-contractors are exposed to delay by the contractor in passing through Government payments for work performed by the sub-contractor and to financial failure of the contractor, which affects not only payments that should have been passed through but also retention. There has been an unusually large number of contractor failures in recent years, and current market conditions cause concern amongst sub-contractors that the failure rate will continue to grow.

17.2   Sub-contractors believe that they must do business with main contractors on Government projects in times of recession in order to sustain their operations. Such times feature the highest incidence of financial failures and payment difficulties. It must be admitted that the problem is (at least for the nonce) genuine.

International Practice

17.3   International practice is similar to the current GCCs with respect to sub-contractor payment problems with, however, one notable exception and two important differences.

17.3.1   The notable exception is found in the ECC, which responded to the Latham Report 31/ by setting up an elaborate trust fund arrangement for protection of sub-contractors.

17.3.2    The important differences are (i) the protection afforded sub-contractors by "stop notice" provisions parallel to mechanic's lien rights in the United States and (ii) the requirement of payment bonds on public works in the United States and elsewhere. Under stop notice laws, an unpaid sub-contractor can (in lieu of a mechanic's lien, which is impermissible on public works) file a notice of non-payment that will cause the employer to withhold the specified sum from future payments to the contractor until the dispute is resolved or a bond (known as a "release bond") is filed. Moreover, it is common practice in the United States to require a public works contractor to post a payment bond, upon contract award and issued by a commercial surety, that guarantees payment to sub-contractors of amounts justly due up to the "penal sum" (customarily the full face value of the works).

17.3.3   Since none of these protective schemes are in play in Hong Kong, it can be said that sub-contractors are more exposed to payment difficulties than is usually the case in international practice.

Recommendation

17.4   Let market forces operate regarding sub-contractor payment. This recommendation means leaving the GCCs unchanged with respect to sub-contractor payment security so long as the subcontractor is free to choose whether to enter a sub-contract with the main contractor. 32/

Justification of Recommendation

17.5   So long as Government does not require sub-contractors to accept engagement with the main contractor, then the sub-contractor can evaluate the financial strength and reputation of the main contractor in order to choose whether or not to do business with that party. This is not any different from the frequent argument by sub-contractors (against "pay if paid clauses") that the main contractor can evaluate the financial strength of the employer.

17.6   Nonetheless, it is fact that sub-contractors have suffered unfair payment problems attendant to contractor insolvency and that it would be good for the health of the construction industry if this could be avoided.

17.7   The elaborate trust fund scheme that was created as an optional clause for the ECC in response to the Latham Report is fraught with legal and practical uncertainty and potentially is very expensive to the employer. 33/ It has not been well-received by English employers, and it is not thought by me to be suitable for Hong Kong public works. 34/

17.8   The use of payment or release bonds would solve the problem fairly inexpensively and bring with it the side benefit of pre-screening of main contractors by a sophisticated commercial surety. However, commercial sureties are not engaged in this business in Hong Kong at this time. I recommend that Government form a joint discussion group with the sub-contractors' association to explore the bonding alternative.

18. NOTICE AND TIME BAR PROVISIONS

Assessment

18.1   Clauses 64 (1) and (2) require the contractor to give notice of claim within 28 days of (i) receipt of valuation notification or (ii) it becoming apparent that an event may give rise to a claim. Clause 64 (5) imposes a bar to any claim not timely notified. Clause 64 (4) requires that particulars of a notified claim be furnished as soon as is reasonable, but particulars furnished more than 180 days from the certified date of completion for the Works need not be considered, according to Clause 64 (6). These clauses are representative of the notice and time bar provisions in the various GCCs that apply to the various entitlements to additional time or money although there are time and starting point variations amongst the GCCs and variations in practice concerning strict enforcement. 35/

18.2   Government has a legitimate interest in timely notices both from a management and a financial perspective. The issue here is how best to satisfy Government's interests and whether the forfeiture penalty is effective or desirable.

International Practice

18.3   International practice is uniform with respect to requiring written notification from the contractor to the employer of claimed entitlement to extra time or money within some period of time measured from some starting point. There are, however, many variations of the allowable period and the definition of the starting point. These variations are not of major significance compared to the variations concerning claim forfeiture. Here it can be said that there are three schools of thought: forfeiture strictly enforced, forfeiture enforced only upon occurrence of prejudice to the employer, and no forfeiture but damages for breach if warranted. There is no common international practice in this area.

Recommendation

18.4   Failure of notice should give rise to damages, not forfeiture. This recommendation means removing condition precedent ("time bar") language from the GCCs but preserving the employer's right to recover for additional costs due to tardy notice.

Justification of Recommendation

18.5   It is a maxim that the law abhors a forfeiture. That is because it is intrinsically unfair to take one's entitlement without any recompense. Only strong public policy reasons are thought to justify such drastic results. As one seasoned quantity surveyor said to me: "No reasonable person would want a time bar."

18.6   Nonetheless time bars frequently appear in construction contracts because employers have concluded that they do not want to be at risk of belated claims that would not stand up if raised contemporaneously or relate to circumstances that could have been mitigated at the time. The problem is that contractors understandably overreact to time bars by "flooding" the employer with (form letter) notices about every conceivable claim trigger. It is then impossible to sensibly evaluate and follow up on every such notice, and the entire process is defeated of purpose.

18.7   Government does not actually need notice from the contractor in most cases. Government representatives will have observed the incident or difficulty equally as have the contractor's representatives. Government may not know whether the contractor will use the incident or difficulty as the premise for a claim, but an intelligent prediction is usually possible.

18.8   What is really needed is prompt, effective communication between Government and contractor about the problem, its impact, its mitigation and its contractual consequences. My recommendation regarding use of dispute resolution advisers will go a long way toward meeting this objective.

18.9   If it occurs that the chance to mitigate is lost through failure of notification or costs to Government accrue as a result, then the contractor should be chargeable with the unmitigated or accrued costs as damages. This will give reasonable incentive to contractors to comply with notice provisions but hopefully will not cause overreaction.

18.10   As a long stop, any claim not identified and reserved in the final payment application should be deemed waived.

19. VARIATION VALUATION

Assessment

19.1   Under the GCCs, the contractor may recover additional Cost (inclusive of overheads and depreciation but exclusive of profit) in the event of employer caused site access delay (Clause 48 (2)) 36/; delay and disruption caused by untimely design information, variations, opening up of works if no defect exists, other prime contractors or late employer furnished materials (Clause 63); or suspension orders arising from act or default of the Engineer or employer or an excepted risk defined in Clause 21 (Clause 54). Additionally, the contractor is entitled to a priced adjustment to the Contract Sum (inclusive of profit) in the event of a variation as defined in Clause 60 (Clause 61). Pricing is based on Contract rates where possible and unless unreasonable (Clause 61). There is an overlap between Clause 63 (b) and the proviso of Clause 61 in that both provide for additional payment in respect of impact on unchanged work by reason of a variation order ("ripple" or "knock-on" effect), but the former contemplates Cost recovery while the latter allows for the more generous price adjustment. Where appropriate, the Engineer may elect to have extra work performed on a daywork basis (Clause 62).

19.2   In this area, clarity, ease of operation and the avoidance of price gouging should be the goals. Valuation provisions also can be used as a device for sharing risk.

International Practice

19.3   There is some variation in pricing techniques mandated under the various forms of contract used internationally, but the trend is toward a single set of pricing principles that apply uniformly to all entitlements the contractor may have to additional money. The ECC has captured this concept explicitly.

Recommendation

19.4   Variation valuation should be simplified and tightened. This is a series of recommendations designed to (i) introduce clarity and ease of operation into the process of variation valuation and (ii) eliminate unjustified recoveries. The specific recommendations are:

• Eliminate the dichotomy between Cost compensation and priced compensation.
  
  
• Express and operate a preference for lump sum forward pricing.
  
  
• Eliminate or fix the rate of recovery for home office overhead.
  
  
• Fix the rate for profit mark-up.
  
  
• Prohibit global claims.
  
  
• Eliminate the overlap between Clauses 61 and 63 (b).
  
  
• Require sub-contractor pricing to be compliant.

Justification of Recommendation

19.5   Eliminate the dichotomy between Cost compensation and priced compensation. If the contractor is entitled to additional compensation, one wonders why he is not entitled to a profit as well. Certainly it is expected that contractors are entitled to receive profit mark-up on costs as part of the tendering process. I am unable to discern why it should be different in the extra compensation context. Elimination of the dichotomy would allow simplification in that a single set of pricing principles would apply to all compensation events.

19.6   Express and operate a preference for lump sum forward pricing. For all the reasons that lump sum contracting is preferred, lump sum forward pricing of variation work also is preferable. It is the simplest method, and the possibility of future dispute is obviated. Although there can be no proof, informed intuition is that Government will receive the lowest price on this basis. Alternative methodologies such as daywork should be available if the price quoted is considered unreasonable.

19.7   Eliminate or fix the rate of home office overhead recovery. It is well known that standard formulae for calculation of home office overhead produce windfall profits to contractors in most delay cases and all suspension of work cases. It is debatable whether home office overhead costs are in fact increased by delay. Government can eliminate this entitlement without causing damage to or resentment by contractors. Alternatively, Government can fix the rate at a very low percentage of costs.

19.8   Fix the rate for profit mark-up. Pricing can be simplified and disputation reduced by fixing the rate for profit mark-up. Where the entitlement is being priced ex post facto, there need be no allowance for risk, and the profit mark-up can be as low as 5 percent without being unfair. In connection with forward-priced lump sum quotations, the rate might reasonably be as much as 10 percent to allow some cushion for risk of under-estimation and to provide incentive to forward price.

19.9   Prohibit global claims. Global claims (sometimes referred to as "rolled up" or "total cost" claims) proceed from the premise that so many things for which the employer is responsible impacted so much of the work so pervasively that it is impossible for the contractor to prove up his entitlement discretely and, therefore, he should be paid for his costs plus a mark-up for profit. Many courts have allowed such claims in principle although putatively as a last resort. This claims methodology is especially pernicious to employers as it assumes causation and inverts the burden of proof. I recommend contractual prohibition.

19.10   Eliminate the overlap between Clauses 61 and 63 (b). There is no reason for this confusing overlap. It will disappear naturally if the dichotomy between Cost recovery and priced recovery is eliminated.

19.11   Require sub-contractor pricing to be compliant. Pricing principles that apply to the main contractor should apply also to that portion of any claim which is based on subcontractor pricing. Otherwise most of the value of the claim will escape the pricing rules.

20.   DISPUTE RESOLUTION

Assessment

20.1   The GCCs provide for a prompt initial determination by the Engineer, then to voluntary mediation, then to arbitration although all kinds of alternative dispute resolution techniques have been experimented with, including mandatory mediation, mediation with a decision, adjudication, dispute review boards, dispute resolution advisers and short-form arbitration.

20.2   Government needs no advice as to the available mechanisms for alternative dispute resolution and does not lack experience in employing them. Techniques for eliminating delayed dispute identification and prolonged dispute resolution processes are what is needed.

International Practice

20.3   As in Hong Kong, international practice embraces some form of alternative dispute resolution in lieu of litigation. Partnering is now popular in the U.S.A. The use of dispute review boards has been found to be particularly effective for civil engineering projects (with, however, some notable exceptions 37/). Mediation and arbitration continue to be the workhorses for resolution of most disputes.

Recommendation

20.4   Use dispute resolution advisers widely and make "no-decision" mediation "voluntary." This recommendation means wider use of dispute resolution advisers on projects of size or complexity and restoring mediation to its classic form.

Justification of Recommendation

20.5   The use of a dispute resolution adviser ("DRA") reportedly 38/ has been beneficial on several difficult public works projects in Hong Kong. The DRA system 39/ is a hybrid of alternative dispute resolution techniques that borrows heavily from the partnering and mediation concepts. It promotes early appreciation of risks, open communication and prompt resolution of difficulties. 40/ If fully embraced, the system should nearly eliminate the possibility of claims falling to formal resolution by arbitration. Because it adds expense to the process, it cannot be used on every project, and it should not be needed on routine public works, but large, complicated projects all should be considered candidates for a DRA.

20.6   Mediation has proved successful internationally in resolving most of the claims submitted. Imposing the requirement of a mediator's decision converts the process to a mini-arbitration, which may be desirable in some cases but which robs the mediation process of its informal, negotiative characteristics. Consequently, I recommend against requiring a mediator's decision (although the parties could request it if both agree that it would be useful). I also think it important that the mediation process be voluntary because of the futility of forced negotiation. The objection that a party will be viewed as weak if he consents to a voluntary mediation can be overcome by the simple expedient of requiring mandatory mediation with a voluntary opt-out provision.

20.7   Adjudication (whether by an adjudicator or a dispute review board) is facially attractive because it holds out the promise of immediate, informed, appealable resolution of disputes when the evidence is fresh and the parties can most benefit from knowing the view of an impartial arbiter. It should work well for short, sharp, clear disputes. Experience shows, however, that short, sharp, clear disputes do not often arise on construction projects, or if they do, they do not matter very much. Ugly, tough, complex disputes that matter a lot do not lend themselves to resolution by adjudication. It is doubtful that either party would want such disputes decided by an adjudication process unless the adjudicator has a perceived or actual bias.

21.   VALUE ENGINEERING

Assessment

21.1   There is no express provision in the GCCs for acceptance of an alternative design proposed by the contractor (commonly denoted "value engineering" proposals in U.S.A. parlance) after the award of the contract (such alternative design, which may be just minor changes, is currently dealt with under a separate agreement which is administratively inconvenient).

21.2   The concern that variation orders should not be used to adopt alternative design proposals appears artificial. Clause 60 (5) in the Design/Build GCCs has it right.

International Practice

21.3   International practice is to adopt desirable alternative design proposals by means of variation orders with an accompanying adjustment (usually a reduction) of the Contract Sum.

Recommendation

21.4   Adopt Clause 60 (5) of the Design/Build GCCs across the board.

Justification of Recommendation

21.5   The ability to accept useful value engineering proposals without inconvenience is obviously desirable for the employer.

FINANCIAL IMPLICATIONS

22.   The Issue

22.1   The objective of these recommendations has been to promote the public interest in receiving best value for money in the procurement of public works. Yet, several of my recommendations (offset perhaps by others) involve changing the risk equation in favor of contractors. That will cause the cost consequences of risk materialization to fall on Government. The issue, then, is whether changing the risk equation is consistent with the objective. There are several reasons to think so.

23.   The Answers

23.1   To the extent that contractors are including contingencies in their tender pricing for the risks in question, then Government is paying for the risk whether it materializes or not. Over many projects, this could be a substantial waste of public funds as it will aggregate to a greater amount than the direct costs of rarely occurring materialized risk.

23.2   To the extent that contractors are not including contingencies, the current risk allocations tend to encourage gambling and guessing, which in turn leads to lower calibre contractors receiving Government awards. These contractors will consume more Government management resources and deliver lower quality work less reliably than their more conservative and competent competitors. They are more prone to financial failure during performance and more likely to embroil Government in disputes. Over many projects, this too could be a net waste of public funds.

23.3   Even the most reputable and competent contractors will do their utmost to transfer risk back to the employer or recoup losses by other means if the risk allocation is viewed by them as inappropriate, unfair by international standards or threatening to company survival. This means disputes. 41/ And the disputes likely will be hard to resolve because they will be thin on legal and contractual justification and long on desperation. The cost to Government of dispute-ridden projects is enormous. The direct costs of defending alone are very high. The indirect costs of losing focus on and control of the construction process can be much greater. In my opinion, these costs will be higher than the direct costs of accepting the risks which I have identified as candidates.

23.4   I cannot prove the cost equation by empirical evidence, and I do not believe that others can. Moreover, I do not fully trust surveys of contractors, even though the contractors have the best information. But, I can say that many who have studied these issues agree with my conclusions.

23.4.1   To begin with, every Government, every international employer and every financing party (such as the World Bank) that has adopted GCCs with risk allocations congruent with those I recommend has done so not out of altruism but because of a conclusion that there is financial justification.

23.4.2   The sponsors of the international forms of contract identified in paragraph 3.5 (ICE, FIDIC, etc.) can be taken to agree.

23.4.3   The Mass Transit Railway Corporation can be taken to agree.

23.4.4   The Construction Industry Institute, the Center for Public Resources, the American Society of Civil Engineers, and the Risk Allocation Subcommittee of a Joint Working Party of the Australia National Public Works Conference and the National Building and Construction Council all agree.

23.4.5   A plethora of respected industry savants 42/ have expressed agreement in their published works.

23.5   To the contrary, however, many employers take the view that their interests are best served by transferring as much risk to the contractor as the market will bear. I suggest that there usually are special reasons for this which do not apply to Government public works. Certainly the rationalia are different for the one time or occasional employer than for a repeat employer on the scale of the Government of the Hong Kong SAR.

CONCLUSION

24.   These recommendations need not be viewed as a package; each will stand on its own feet. However, three of them -- ground conditions, utility interferences and impossibility -- are interrelated and lend themselves to joint consideration. I also think that the recommendations work well together as a group. In general, the recommendations assign unfathomable risks to Government while tightening the compensation rules so as to avoid unwarranted recoveries. If adopted, they will appropriately balance risk allocation on Hong Kong public works projects.

25.   I trust and hope that Government will find this Report to be worthy of consideration and implementation.

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ENDNOTES

1/   The current revision of, e.g., the General Conditions of Contract for Civil Engineering Works, is the 1993 Edition, but a 1998 Edition has been prepared. The Airport Core Program featured numerous revisions in 1992 and 1993.

2/   The Joint Discussion Group evolved into the Contracts Committee of the Construction Advisory Board.

3/   M.J. Byrne, Principal Assistant Secretary (Works Policy and Safety).

4/   Secretary for Works.

5/   Index at Appendix A.

6/   Viz, Architectural Services Department, Drainage Services Department, Housing Department, NAPCO, Territory Development Department, Water Supplies Department, Highways Department, and Electrical and Mechanical Services Department.

7/   The Asian Development Bank has adopted this form with some minor amendments to, e.g., the dispute resolution clause (adjudication required).

8/   The World Bank has prepared its Standard Bidding Documents, Procurement of Works ("SBDW," as used in this footnote; "World Bank" as used in text above) for use by borrowers in the procurement of admeasurement type of works contracts through international competitive bidding. The SBDW is mandatory for use in works contracts financed in whole or in part by the World Bank that are estimated to cost more than US$10 million unless the World Bank agrees to the use of other standard bidding documents that it has prepared.

The current edition of the SBDW (dated 1995) is based on Part I of the fourth edition of the FIDIC Red Book (1987, reprinted in 1992 with amendments), as well as changes to it resulting from the Bank's experience. The following FIDIC Red Book sections referenced in the attached Appendix B have been modified by the SBDW: (i) Changes in Law; (ii) Variation Valuation; and (iii) Dispute Resolution.

9/   Appendix B.

10/   For example, the use of a remeasurement form largely transfers the risk of ground conditions to the employer notwithstanding a clause like Clause 13 as confirmed by the Privy Council in Mitsui v. The Attorney General of Hong Kong.

11/   The FIDIC Orange Book Guidance Notes suggest this methodology.

12/   As is current Government practice with respect to, e.g., disturbance to the progress of the work arising from Utility undertakings.

13/   The Business Round Table. Contractual Arrangements: a construction industry cost effectiveness report. U.S.A., 1982. For a collection of estimates of price savings through "rational" risk allocation, see Smith, Allocation of Risk -- The Case for Manageability, 13 International Construction Law Review ("ICLR") 549, 1996.

14/   The foregoing list was drawn from Engineering Construction Risks by Thompson and Perry, Science and Research Council, 1992.

15/   Abrahamson, Risk Management, 2 ICLR 241, 1984.

16/   It has been suggested that further separation should be accomplished by assigning to independent (from the Engineer) quantity surveyors the Engineer's traditional roles of variation valuation and contract interpretation on civil works. I am not persuaded that this is necessary or desirable. See paragraph 11.1, infra.

17/   The first bullet item is a feature that should be common to all construction contracts, according to the Latham Report (full cite at fn. 31).

18/   The Airport Core Program notice provisions are very well done.

19/   In considering my following recommendations, I have assumed that the delivery system will not include either remeasurement or fluctuations clauses, both of which operate to place substantial risk on the employer.

20/   This welcome development was introduced in the ECC, Clause 60.1.

21/   Some examples might include a failure of funding, revised needs, a reassessment of side effects, or even a realization of impossibility of performance.

22/   Clause 55 of the GCCs for the Airport Core Program captures the concept.

23/   I do not foresee any risk that time could be set at large in the absence of this catch-all. The premise for the fear is that there could be a "justified" basis for time extension not covered by the specific grounds set forth in Clause 50. The premise is self-contradictory. If the event is not listed in Clause 50, it cannot be a justified basis for time extension.

24/   References to clause numbers are to those in the General Conditions of Contract for Civil Engineering Works unless otherwise noted.

25/   An alternate Clause 13 shifting the risk to Government is available in the Design/Build GCCs, but it is rarely used, perhaps because of the difficulty of tender comparison thereby introduced.

26/   See, Knutson, Common Law Development of the Doctrines of Impossibility of Performance and Frustration of Contracts and their Use and Application in Long-Term Concession Contracts, 14 ICLR 298, 1997.

27/   Long ago, an English judge thought it impossible to retrieve a coin from "deep" water.

28/   Two of the utilities in Hong Kong are Government Departments: the Water Supplies Department and the Drainage Services Department.

29/   It arguable that Government Departments are not utilities for this purpose.

30/   Nominating sub-contractors is archaic and not often done by Government.

31/   Constructing the Team by Sir Michael Latham, the Final Report of the Government/Industry Review of Procurement and Contractual Arrangements in the UK Construction Industry, July 1994.

32/   This is an important condition. The recommendation would be different if the "nominated sub-contractor" practice were in effect.

33/   For a critique of the trust fund scheme, see Cornes, The Second Edition of the New Engineering Contract, 13 ICLR 97, 1996.

34/   The reason why the clause is optional is that the authors anticipated that there would be those, like myself, who are unmoved by this recommendation of the Latham Report.

35/   For example, the Project Administration Handbook (at Chapter 7, 8.1.1 (c)) advises against strict enforcement of the time bar related to time extensions where no prejudice has occurred to the employer as a result of late notice.

36/   Except that a daily rate is frequently made applicable by special condition.

37/   Including the Channel Tunnel Project, the Los Angeles Metro Project and, I believe, the Chep Lap Kok Airport Project. The reason is that DRBs are good at resolving technical issues but not so good at difficult commercial and contractual disputes.

38/   For example, Stipanovich, The Multi-Door Contract and Other Possibilities, 13 Ohio State Journal on Dispute Resolution at 387, 1998.

39/   For a complete description, see The Use of Dispute Resolution Advisor System in Building Projects, Architectural Services Department, 1996 and The Dispute Resolution Advisor System by Colin J. Wall, Commercial, Mediation & Arbitration Services, Ltd., 1995.

40/   The special expertise and experience of the quantity surveyor suggests their fitness to serve in the role of DRA.

41/   Contractual misallocation of risk is the leading cause of construction disputes in the United States, according to the Center for Public Resources, Inc. in Preventing and Resolving Construction Disputes, 1991.

42/   Some are listed in Appendix C.