Guaranteed Maximum Price Contracts – An Overview
Both the Employer and Contractor may find a guaranteed maximum price arrangement attractive. For the Employer, a major advantage is that the Employer is relieved from the worry of the project exceeding the budget. The Employer is attracted by the Guaranteed Maximum Price element a Guaranteed Maximum Price Contract. This is coupled with the attraction of the Scope of Works being fixed. On the Other hand the Contractor is attracted by the potential of being able to share in cost savings. The contractor is also likely to be encouraged by the Scope of Work being fixed, rather than being subject to major or continued changes at the hands of the Employer’s design team. He can also see the potential for large profits if the Employer has failed to develop his Scope of Works to a sufficient state where variations are no required which is rarely the case.
Very few Malaysian contractors have any experience of Guaranteed Maximum Price Contracts who consider the financial and programme risks for unforeseen circumstances too high
Generally, a Guaranteed Maximum Price Contract arrangement tends to be one that seeks to involve the following four elements:
The Guaranteed Maximum Price.
An agreed Scope of Works, against which changes to the Guaranteed Maximum Price will be evaluated.
A mechanism by which the Guaranteed Maximum Price may be adjusted, if the scope of works is varied by the Employer.
A mechanism by which the Contractor may suggest cost saving changes to the scope, with the savings to be shared in some way between the Employer and the Contractor.
As with all forms of project procurement, the Guaranteed Maximum Price arrangement can work and has produced successful results on various projects. However, like all forms of project delivery, there are disadvantages and potential problems. For the Contractor, the worst scenario is being bound to stay within the guaranteed maximum price, yet being contractually bound to construct something which is considerably more expensive than this. For the Employer, a similar scenario would be being contractually bound to pay the full guaranteed maximum price, but in return getting a building or facility which is inferior in some way to what he anticipated at the time of entering into the contract with the Contractor.
With respect to the budget let us start by discussing the ‘price’ in the Guaranteed Maximum Price scenario; it is evident that there is likely to be a basic conflict of interest here between the Employer and the Contractor. The Employer wants to set the ‘Price’ as low as possible, whereas the Contractor will seek a higher ‘Price’.
The Price is negotiated with the chosen Contractor and his Sub-Contractor(s) on a basis that includes for the Contractor’s future design development of the scheme, albeit in many cases the initial tender methodology may not have included design. The Contractor therefore assume a larger element of risk that with other contract relationships and takes responsibility for matters that would normally be cause to grant extensions to the time for completion and additional payment.
With respect to the Scope of Works the situation is very similar. The Employer will seek to impose the most stringent understanding of the Scope of the Works, where as the Contractor will be looking for gaps in the Scope of Works which he can take advantage of financially. If the Contractor is to be held responsible for delivering the project within the guaranteed maximum price, it is only fair that the Contractor should have the capacity to manage the costs. Equally, however, the Employer will want some protection as regards the quality and standard of what is being built by the Contractor. The Employer will also want to be protected from claims by the Contractor for variations that have occurred, for which the Employer must pay extra.
If the Employer is not wary of the implication of how he draws up the Scope of Works, he might find that the Contractor is taking advantage of the short comings in the Scope of Works documentation, which will lead to the Employer regarding what is actually performed by the Contractor as a lower quality or standard in the finished project as to what the Employer thought he was getting at the onset.
The above two points clearly indicate a further point. There is a school of thought that the dynamics between the guaranteed maximum price on the one hand and the Scope of Works on the other hand is such that it is preferable for the design to be as advanced as possible before the Scope of Works and the guaranteed maximum price are fixed. Some may think that this is a point that is so obvious that it goes without saying; however, to the parties this is not always the case when such projects are being negotiated.
Given the Scope of Works document and its inter-connection with the guaranteed maximum price together with the costs savings provisions, detailed thought is needed as to what ongoing role the Employer’s consultant team is to play. Sometimes, the Employer’s consultants adopt a role similar to that in a design and build contract arrangement, but this can of course lead to its own problems for the Employer.
The parties to a guaranteed maximum price agreement also need to address their minds to how they will deal with sub-contractors. In order to lessen the perceived risk of the Contractor containing costs within budget The Employer may seek to insist that the Contractor use “domestic” Sub-Contractors from lists nominated by the Employer. This is not necessarily a bad thing, but it can reduce the Contractor’s capacity to stay within the guaranteed maximum price.
Given that a guaranteed maximum price approach differs in various respects from a traditional contract Employers often seek to impose a very limited range of circumstances in which the Contractor becomes entitled to an extension to the time for completion. This often is coupled with stringent notification procedures. Again, the Contractor needs to ensure that this risk is priced within the guarantee maximum price.
The contractor should also ensure that his project team is in tune with what steps that are needed to comply with the contract requirements if the rights to an extension to the time for completion are to be preserved. Employers need to take care that they do not cut down the extension of time requirements to such a degree that might be perceived to prevent in principle the Contractors rightful entitlement to an extension to the time for completion, thus putting at risk the entire enforceability of the liquidated and ascertained damages provisions.
It is not uncommon for the Employer to insist that the guaranteed maximum price contract provide for every circumstance and that the Contractor is not due any additional payment in respect delays or disturbance costs which may become payable to the Contractor. Again, the Contractor needs to ensure that these risks are priced within the guaranteed maximum price and that his project team is briefed on what steps are needed to comply with the contract requirements if the rights to claim additional payment are to be preserved.
The guaranteed maximum price form of contract is a method of project delivery, rather than a form of contract. A Guaranteed Maximum Price Contract can be tendered at outset, but more often a previously tendered lump sum contract (excluding Target type contracts) is converted to a Guaranteed Maximum Price Contract following a traditional single or two-stage tender process utilising Bills of Quantity (either firm or approximate), a Schedule of Rates or Specification and Drawings
Regardless of what form of contract is used the basic position remains the same. Both parties need to ensure that they fully understand what risks they are assuming. The best formula is for there to be open and honest discussions so that there is clarity and a common understanding between the parties.
There is no generally available Standard Form of Contract for a Guarantee Maximum Price; it will require a bespoke contract or a standard contract modified by an addendum agreement or similar.
The creation of a Guaranteed Maximum Price Contract creates a degree of certainty for both parties. However, the Contractor can take a heavy fall if things go wrong. The Contractor should be careful that he is not lulled into a false sense of security by the fact that a standard set of conditions of contract is being used as the nominal starting point for the contract structure as there many changes require to achieve a guaranteed maximum price contract and these need to be taken into account through thorough review and risk analysis.
However, it is also important to note that a Guaranteed Maximum Price Contracts have the potential to provide rich picking grounds for disputes, particularly in respect of whether varied work has resulted from design detailing and therefore included or whether it is a variation caused by an Employer change.