Volume 8 - June 2012

SLQS JournalThe Forum of Sri Lankan Quantity Surveyors Across the Globe

Volume 8 June 2012

Editorial Committee

Dhammika T. Gamage NDT(Civil Eng.), ICIOB, ACIArb, AAIQS, AIQS-SL, FIIE(SL), IEng, FACostE, FCInstCES

Lakshman Gunatilake GCGI, MBA (Sri J.), FCMI, FQSi, MCInstCES, ACIArb, MIIE(SL), IEng, PMP

Manju Sri Adikari BSc. (Hons), MRICS, MCIArb, MIIE (S.L.) I Eng, GCGI (UK)

Nishantha Fernando, BSc(QS) Hons, MRICS, MAA

Prasanna Pushpajith DipSurv., MSc, MRICS, ACIArb

Sudeera A. Widanage., BSc(QS) Hons, MRICS

Editorial Policy

We, the editorial committee reserve the right to select, reject, edit, and excerpt articles at our sole discretion. We will publish no article which, in the opinion of the editorial committee, can be reasonably interpreted as insulting or offensive to any individual or group. We will not return unsolicited manuscripts. The opinions expressed in articles contained in the SLQS Journal are the opinions of individual authors and not necessarily those of the SLQS Journal editorial committee. Articles are provided for the general interest of the quantity surveying and contract administration community, but the

information contained therein does not constitute legal advice and should not be relied on as such. Neither the SLQS nor the individual authors assume any responsibility for the accuracy of information reported.

The editorial committee assumes no responsibility for failure to report any matter inadvertently omitted or withheld from it. The mode of citation utilised within the articles and for the bibliography would be the Chicago method.

Email your own creations to journal@slqs-uae.org with your passport size photograph and brief profile of yourself which should not be more than 35 words.

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CONTENTS Editorial

Four Reasons for Adopting Adjudication Process in UK Construction IndustryMurugesu Sathiyaseelan LLM (with Merit), FRICS, MCIArb

Demystifying a Mechanism to Deal with Open Market VacillationsDr. Chandana Jayalath D.Sc, M.Sc, B.Sc (QS) Hons, PG Dip (Cons Mgt), PG Dip (Intl Mediation), FRICS, FIQS (SL), MCIArb

Performance security and possible alternative mechanism for performance security in the economic downturnSampath Marasinghege, B. Sc Hons (QS)

Why most UAE clients go for Lump Sum building contractsS.M. Asanka Sanjaya Kumara, BSc (Hons), NCT(QS)

Letter of Intent (LoI) and its importance in the construction industryC. J. Quickson BSc (Hons), LLM (Constr. Law & Arb) , AAIQS, MRICS, CCE, MCIArb

Internal Auditors are at Site!Saman Jayasiri Sirisoma Welagedara, BSC (Hons) , MRICS

The Steps an Arbitrator should take before and During a Full Oral Hearing Priyankara Premarathna, HND QS, ACIArb

Which Procurement Route? Prasanna Jayaweera, B.Sc (Hons) QS, MRICS, CCC, ICIOB

On and Off Site Recoveries Vajira Kosala Hettiarachchi

Prevention PrincipleSenerath Wetthasinghe LL.M., AIQSSL, AAIQS, MQSi, FCIArb

Drafting a Construction Contract AgreementKidneswaran Kajanantha, B. Sc. in QS (Hons.), AAIQS, MRICS

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Editorial

Dear Sri Lankan Quantity Surveyors,

As we start experiencing summers burn in the UAE, Europe and North America are being buffeted by the heat of desperately flailing economic waves. The emerging BRICS economies are also about to experience theburn of the same global economic waves, with India being the first of the member nations to feel the heat.The professionals associated with the UAEs construction industry one of the most impacted by the global economic downturn - cannot think of any easy shelter from this scorching heat. Therefore, we, as sound contract administrators, have a duty to deliver with due diligence, in order to avoid any actions that could further worsen the existing crisis. On that note, we hope the 2012 Olympics will bring a cooling breeze to the economic shores of the UK.

We are pleased that we managed to release the overdue 8th Volume of this journal and hope that it brings you as much gratification as the ones preceding it.

Murugesu Sathiyaseelans promotion of the adoption of adjudicationas a most cost-effective and speedy alternative to lengthy arbitration and litigation can be considered one of the more appropriate topics to whisper within the construction industry. Similarly, Dr. Chandana Jayalaths article complements the sentiments expressed earlier perfectly. Likewise, Sampath Marasingheges proposal is another effective tool to eliminate the fear of undue encashment of performance securities.

While Prasanna Jayaweeracomprehensively discusses procurement routes and strategies in general, Asanka Sanjaya Kumara focuses on the specific desire for lump sum building contracts among UAE clients. The articles by Senarath Wetthasinghe, C. J. Quickson and Priyankara Premaratna display an excellent trend in career progression, towards construction dispute resolution, with the first in particular being a comprehensive treatment of the Prevention Principle. The article by Saman Welagedaraprovides a look at regular contract administration practices.Vajira Kosala Hettiarachchis well-written article goes on to add further merits to the Samaratunga Formula. Kidneswaran Kajananthas article has so cleverly documented Prof. Sams seminar that it evokes the feel of the very auditorium in which the seminar used for the article was delivered.

On a cheerful note, you may once more see a new name, that of Mr. Sudeera A. Vidanage, amongst the members of the editorial committee, whose thanks go to him for his commitment to delivering this excellent reference to you.

To bring this editorial to its terminus, we ask all our readers to recall that this journal is your property. As such, its performance is indeed your concern and all feedback and articles are not only appreciated, but an active part of being a member of the SLQS and the construction community. We anticipate your academic pleasure and hope that you assist us in ensuring it for future readers as well, by providing high-quality articles of your own in the near future.

On behalf of the editorial committee,

Dhammika T. Gamage

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Murugesu Sathiyaseelan LLM (with Merit), FRICS, MCIArbExecutive Surveyor working with Gardiner & Theobald since August 2003, Counsellor and APC Panel Chairman of RICS UAE

Four Reasons for Adopting Adjudication Process in UK Construction Industry

When a conflict arises between parties in construction industry and if the parties cannot resolve such conflicts by themselves, it will be handled entirely by others (by a judge). This means the matter will be referred to courts (litigation).

Adjudication is similar to litigation and has developed in recent years in the UK as Construction adjudication or adjudication. The Oxford English Dictionary defines the word adjudicate as:

(Of a judge or court) decide upon (claim, etc) and sit in judgment and pronounce sentence Adjudication is a procedure that results in a decision that binds the parties and will, in all usual circumstances, be enforced by the court.

Many doubts were expressed while the Act was being passed in the Parliament as to the appropriateness of adjudication for the resolution of disputes and whether it would have the desired effect. Enforcement was a matter of great concern.

Concerns relating to the enforceability of the adjudicators decisions were put to rest by the courts when Mr Justice Dyson, as he then was, gave his judgment in the Macob Civil Engineering Ltd v Morrison Construction 1999 case.

The case established inter alia the following issue:

Whether adjudication is in reality a speedy and convenient dispute resolution process, and whether in the practice of the UK construction industry adjudication has become, as Mr Justice Dyson considered it to be in 1999, more than merely an intervening provisional stage in the dispute resolution process

which has to be critically analysed considering the above issue about the adjudication principles.

It is, therefore, appropriate to consider the following major issues of the case:1. Is it a speedy process?2. Is it an intervening provisional stage in the dispute

resolution process?3. Why are principles of natural justice required in

adjudication?4. Is adjudication convenient for dispute resolution?

Is it a speedy process?In the 1990s, arbitration was seen as unduly slow and expensive and incapable of providing an effective remedy for contractors and subcontractors who were unable to obtain payment for work carried out (John Uff, Construction Law, 9th Edition, Sweet & Maxwell, London, 2005, page 63).

Also, litigation is a very lengthy process. Before any one starts litigation the parties were asked to look into any other available alternative dispute resolutions available in the contract to settle disputes.

Since Lord Woolf produced his report Access to Justice in 1994, more and more interest has been shown in keeping the cases out of court and resolving them by more appropriate and less costly means. As in the case of litigation in recent years construction adjudication was developed to deal with construction industry disputes.

Adjudication was introduced as a statutory right in construction contracts in the Housing Grants, Construction and Regeneration Act 1996 (HGCRA 1996), which came into force in the UK construction industry on May 1, 1998.

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Adjudication is a dispute resolution process employed in the construction sector which as per 23(2) Pt 1 Scheme (The Scheme for Construction Contracts Regulations 1998) and Section 108(3) of the Act (Housing Grants, Construction and Regeneration Act 1996) states that:

The Contract shall provide that the decision is finally determined by legal proceedings, by arbitration (if the contract provides for arbitration or the parties otherwise agree to arbitration) or by agreement.

The parties may agree to accept the decision of the adjudicator as finally determining the dispute

The adjudicator must reach his decision as per s.108 and as per regulation No. 19 of Pt1 Scheme (The Scheme for Construction Contracts Regulations 1998) as described below:

Regulation-19(1)(a)28daysafterthedateofreferral notice

Regulation-19(1)(b)42daysafterthedateofthe referral notice if the referring party consents

Regulation-19(1)(c)Anyotherperiodexceeding28 days after the date of referral notice as the parties may agree after the giving of notice

After the Act came into force many criticisms that as per the statutory rights the adjudication has to be carried out within a narrow time frame which could be unreasonably tight so as to result in injustice. Parliament is aware of this.

The Macob Civil Engineering Ltd v Morrison Construction 1999 case which was the first enforcement case to come before the court. In this case paragraph 14 [defines the above statement?] and also states that the time frame for adjudicator is very tight (see s.108 of the Act).

Lord Abernethy in Ritchie Brothers Ltd v David Philip Ltd 2005 stated that the Parliaments intention in providing for the right to refer disputes to adjudication was to introduce a speedy mechanism by which to settle disputes in construction contracts on an interim basis. The aim of the scheme was clearly to reach a decision within a short time. The time limit act is mandatory.

The following are a few of the subsequent cases among many that followed the judgment in the Ritchie Brothers case:

Epping Electrical Co Ltd v Briggs & Forrester Ltd 2007,

St Andrews Bay Development Ltd v HBGManagement Ltd 2003,

BarnesandElliottLtdvTaylorWoodrowHoldingsLtd 2003,

Hence, it is opined that the adjudication process is a speedy mechanism for settling disputes among other dispute resolution processes and was one of the intentions of Parliament in enacting the scheme as stated in the Macob case.

Is it an intervening provisional stage in the dispute resolution process?

The intention of the Parliament was to introduce a speedy mechanism to settle disputes in the construction industry on a provisional interim basis and the adjudicators decision was to be enforced pending final determination of disputes by arbitration, litigation or agreement of the parties. Section 108 (3), 23 (2) Pt 1 Scheme as stated in the Macob case paragraph 29 states:

29. What the defendant could not do was to assert that the decision was a decision for the purposes of being binding and enforceable pending any revision by the arbitrator. In so holding, I am doing no more than applying the doctrine of approbation and reprobation. A person cannot blow hot and cold: see Lissenden v CAV Bosch Ltd (1940) AC 412, and Halsburys Laws (4th edn) vo.6 para 957 and 958. Once the defendant elected to treat the decision as one capable of being referred to arbitration, he was bound also to treat it as a decision which was binding and enforceable unless revised by the arbitrator.

The Adjudicators decision is of a temporarily binding nature which is clearly set out in Regulation No. 23 (2) of Pt1Schemethedecisionshallbebindingonthepartiesand they must comply with it until such time as the dispute is finally determined by litigation, arbitration (if arbitration is provided for in the contract), or agreement between the parties.

In Herschel Engineering Ltd v Breen Property Ltd 2000, the adjudicators decision was not final or binding on the parties; unless the parties agreed otherwise, the adjudicators decision could be superseded by that of either an arbitrator or the court.

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Also, it is worth reproducing the passage (paragraph 8) from another case of Costain Ltd v Strathalyde Builders Ltd2004-Judicalcontrolofadjudicatorsdecision:

8) the decision of an adjudicator is provisional in nature and may be undone by subsequent arbitration or court proceedings. It is the essence of adjudication that the determination should be capable of speedy enforcement adjudication is conducted according to very short time limits . Under the typical adjudication provisions found in building contracts adjudication is given specific powers to take the initiative in deciding the parties dispute.

the procedure that is followed in practice is accordingly relatively similar to that followed in arbitration, although matters are conducted in a more speedy and summary manner

It could be argued that this may be the reason for the Parliament not to abolish other dispute resolution processes like arbitration and litigation of construction disputes as stated in the Macob case.

Therefore in view of above, that adjudication decisions were simply an intervening provisional stage may have been what Parliament anticipated and intended, as suggested by Dyson J in the Macob Case.

Why are principles of natural justice required in adjudication?

Further to the above two issues, -a speedy process andan intervening provisional stage in the dispute resolution processwhichis likelytoresultininjustice-itcouldbeargued that adjudication did not require a fair hearing by complying with principles of natural justice (PNJ).

In Discain Project Services Limited v Opecprime Development Limited 2001, it was deemed that the adjudicator must comply with PNJ and that the courts will supervise such compliance.

Mr. Justice Dyson observed in Macob Civil Engineering Ltd v Morrison Construction 1999 that the procedure is a matter of concern:

Is adjudication convenient for dispute resolution?

The adjudication process is convenient to the parties in many ways as discussed in detail below:

The decision of an adjudicator is binding only until the dispute is finally resolved by other available means, but it appears that well over 90% of decisions are either accepted or result in settlement and in either event do not lead on to further proceedings (John Uff, Construction Law, 9th Edition, Sweet & Maxwell, London, 2005, page 63.)

It is noteworthy that in a recent case -WimbledonConstruction Company Ltd v Derek Vargo 2005- theJudge set out the following principles which should be used in deciding that the adjudicators decision ought to be enforced:

1. Adjudication is a quick and inexpensive method of arriving at a temporary result,

2. Adjudicators decisions are intended to be enforced summarily and the successful party should not be kept out of his money,

3. The probable inability of the successful party to repay the sum awarded may constitute special circumstances rendering it appropriate to stay the enforcement proceedings,

4. If there is no dispute that the successful party is insolvent then the decision will not be enforced.

The judge decided to enforce the adjudicators decision even though it is unlikely that the other party would repay as per the adjudicators decision.

In view of above, these types of provision are not available in other types of dispute resolution. The parties have greater freedom to agree with or reject the decisions unlike in litigation or arbitration. Also, it is a process which could proceed while the litigation or arbitration process is going on.

The adjudication process will help to proceed with the project during the time of dispute and address any cash flow difficulties experienced by contractors and subcontractors (Latham, M., Constructing the Team:Final Report of the Government/Industry Review of Procurement and Contractual Arrangements in the UK Construction Industry, HMSO, London, 1994, at p.91).

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Hadley Design Associates Ltd v Westminster City CouncilQueens Bench Division (Technology & Construction Court) 09 July 2003

Keywords: Construction contracts; implied terms; Notice; Termination; Unfair contract terms

Summary: H, a firm of architects and surveyors, brought an action against a local authority for wrongful termination of a contract.

Abstract: Architects argued thatlocal authority had given them a assurance that their contract will be terminated only on default or the local authority ran out of money. Based on tis perception Architects were induced to enter into a contract showing the reprentation of the same. However, despite this assurance contract contained certain implied terms regarding termination. Case also focused to the applicability of Unfair Contract Terms Act 1977.

Judege: Judge Richard Seymour Q.C

Held: There was no evidence of a collateral agreement limiting the reasons for termination, no evidence that the local authority had made assurances in respect of termination, the contract did not contain implied terms for conditional termination and local authority had not violated Unfair Contract Terms Act 1977. Therefore, the local authority had been entitled to terminate the contract by

giving the notice which it had without needing any reason for doing so.

Then the arbitration or litigation can proceed once the project is completed.

ConclusionIn view of above many of the recent cases which were appealed to enforce the adjudicators decision was enforced following the Macob Civil Engineering Ltd v Morrison Construction 1999 BLR 93; 64 Con LR 1; (1999) CILL 1470, case (which was the first case enforced in 1999 by Mr. Justice Dyson).

The Macob Civil Engineering Ltd v Morrison Construction case asserted that the following intentions of Parliament were achieved:

1) Speedy and convenient dispute resolution process (apparently find it difficult to accept).

2) Adjudication should be conducted in a manner which those familiar with the grinding details of the traditional approach can follow.

3) Enforcing the adjudicators decision (intervening provisional stage until the dispute is finally resolved) pending the final determination - Pay now andArgue Later.

In the UK construction industry most of the standard forms of contract have adopted the Adjudication process by HGRCA (s.108) which is a more cost effective and speeder alternative to arbitration and litigation and convenient. In JCT 98Clause41A; the resolutionofdisputes arising under the contract resolved through Adjudication, the decision of the adjudicator is binding on the parties until the dispute of difference is referred to arbitration (clause 41.A.7.1)

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Dr. Chandana Jayalath

D.Sc, M.Sc, B.Sc (QS) Hons, PG Dip (Cons Mgt), PG Dip (Intl Mediation), FRICS, FIQS (SL), MCIArb Consulting Engineering Group, Doha, State of Qatarjayalathchandana@gmail.com

Demystifying a Mechanism to Deal with Open Market Vacillations

Whenever the majority of contractors are locked into lump sum fixed-priced contracts, open market vacillations are a risk to them, particularly in contracts of long duration. This is not only unfair by the contractor but also unhealthy for the industry in the long run. A surge in material costs may considerably affect their bottom lines where profit margins are not as high as they once were. As a result, contractors have been searching for recovery means through claims on their own basis whenever a mechanism to deal with price escalation is absent in the contract. Many contractors use the consumer price index (CPI) as the basis of their claims although the purpose of the index is something else.

Indeed, it may be cheaper in long run for the employer to pay for what did happen rather than what the contractor thought might happen in those areas of doubt which the contractor cannot influence. In line with this principle of construction economics, a method to deal with price escalation allows the tenderers to overcome the risk of providing an additional mark-up for unforeseen price variations. The benefit of the doubt would then be passed on to the employer in a deflation since any contract price adjustment is applicable both ways. Since the aim behind any mechanism should be to reasonably reimburse the contractor for those eventualities he could not reasonably foresee in advance, it must eventually reflect an equitable risk sharing between the employer and the contractor.

Similarly, many standard forms of contract provide a mechanism for contract price adjustment due to open market escalation in specified construction inputs such as major building materials, hire charges of plants, and wages for labour. The choice of these inputs largely depends on the cost significance in the overall share for the quoted tender price. Therefore, the adjustments to the contract price shall be made in respect of not only

a rise but also a fall in the cost of materials and other inputs affecting the cost of the execution of the works. Together with the traditional methods of calculating this escalated component using contemporary records, there are formula methods such as NEDO, Osborne, Baxter, Haylett, and ICTAD, to name a few. In all cases, the fluctuated component is ascertained on the difference between the indices of costs of construction labour and materials at the time of tendering and the current values of those indices at the time of escalation in accordance with a predetermined relative proportion for each cost index.

Although a formula method is fairly straightforward and simple to administer, it is difficult to introduce in countries where there is no promotional entity to publish construction indices acceptable as a single source authentic cost database for budgeting, estimating, bidding and cost validation. Since accurate input proportions and reliable cost indices are integral elements in such a mechanism, a traditional approach in an easy-to-understand manner, (by removing complications) helps in the pursuit of a reasonably compensable amount. As such, the first task must be to lay down a couple of parameters, as follows:

1. For example, the projects the duration of which exceeds one (1) calendar year may only be considered for reimbursement of any price escalation on the assumption that the contractors are in a safer, if not better, position to foresee the likely price escalation at the time of bidding for shorter durations. This can be changed to six months, if necessary and the projects eligible for price escalation defined accordingly.

2. The contract price adjustment will be made only on the selected items in the Bill of Quantities. Many admin issues such as site delivery, calculating

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wastage, materials excess, and double or multiple handling (on and off site) do not arise whenever the adjustment is made in relation to the physical quantity of permanent work at site in which the fluctuated materials have been consumed. In case the escalation is ascertained on the material purchase, then it may be a case where payment may be made even before they are consumed in the works.

3. Once the escalation mechanism is connected with the physical quantity of work done instead of materials purchased, it avoids a glaring anomaly where the payment on escalation caused by the increase in prices of certain materials may be made at a time when such materials were not used at all. Also, it avoids over compensation on over purchased materials, materials wastage in transit, usage and in application, and redundant materials at the practical completion.

4. A couple of specified materials of a selected set of work items can only be considered for price adjustment on the basis of cost significance. As per the Pareto principle, it is usually 20% of the bill items that represent 80% of the cost on the total project which is true of building projects and not far wrong of civil projects.

5. The adjustments to the contract price can only be considered in respect of price fluctuations varied by more or less than for instance 10% of the prices which prevailed fourteen days prior to the scheduled date of submission of tenders compared with the prevailing prices at the time of procurement (in accordance with the materials procurement plan as approved by the engineer from time to time). In a price drop the employer will gain the benefit of price reduction once the cut off limit is exceeded. However, if the current price is within a margin of 10% above or below the basic price, then the basic price shall remain unaltered, meaning there will be no claim on price escalation. However, the contractor has to use due diligence in procuring materials in required quantities at the right time and deliver the materials without causing unreasonable wastage, since the burden of any occasional slip may definitely fall on him.

6. Only the net difference in prices shall be considered in the adjustment exclusive of profit and overheads of the contractor. The whole idea is to prevent profiting out of economic losses but bring the losing party

back to the original position financially had there been no fluctuation. Accordingly, the adjustment to the contract price shall be calculated by applying the net difference in prices to the quantity of work done during the period where fluctuated materials were consumed under respective specified items of permanent works.

7. The adjustment shall only apply up to the estimated quantities in respect of lump sum contracts (except where the quantity changes have been considered a variation eligible for contract price adjustment) and actual quantities in respect of traditional re-measure contracts.

8. It can also be reasonably assumed that the rates for varied works are already inclusive of any escalation except those priced with existing bill rates.

9. The materials incorporated into permanent works shall only be considered for cost reimbursement partly because temporary works can be of multiple uses in other projects. Therefore, any temporary works, plant and equipment, tools and consumables, as well as small items are not matters for concern.

10. Omitted works and employer- supplied materials can also be ignored in the adjustment of contract price.

In administering, a detailed tender price break-up plays an important role in deciding on the price quoted for materials, showing separately the other cost elements such as labour, plant, tools, wastage, site and head office overheads, and profit, as well as trade discounts on bulk purchases. Hence, the purchase price at actual procurement will establish the current rate excluding the cost of delivery to site.

However, there are mechanisms that mandate the contractors to follow employer- supplied fixed rates for selected materials with a list of accredited suppliers. One would argue that accreditation helps in reaching the economic order quantity (EOQ). EOQ is essentially an accounting formula that determines the point at which the combination of order costs and inventory carrying costs are the least. The result is the most cost effective quantity to order. However, the EOQ model is based on the assumptions that the demand rate is constant, recurrent and known (assumed to continue the same level of demand for an indefinite future time with no random variance); the lead time is constant and known (lead time from order placement to order delivery is always

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a fixed number); no stock outs occur and materials are ordered and produced in a lot [of batch?] and the lot is placed into the inventory all at one time. The unit cost is constant and no discounts are given for bulk purchases. The purchasing cost per unit is unaffected by the quantity ordered and the carrying cost depends linearly on the average inventory level. This approach to determine EOQ which involves optimizing costs of holding stock against costs of ordering stock has been subject to much controversy. In addition to concerns about the validity of some assumptions, more recently, criticisms emerged of the underlying rationale of the approach itself. In order to keep the EOQ model relatively straightforward, it is necessary to make assumptions related to stability of demand, existence of fixed identifiable ordering cost, and the cost of stockholding and so on. While none of these assumptions is often strictly true, at times these assumptions do pose severe constraints to the model. Although the most fundamental criticism of the EOQ approach comes from Japanese inspired JIT philosophies, it would be too difficult a task for construction commercial managers to find out representative costs of ordering and stockholding in the light of these cost variables. Where the forces of supply and demand tolerate the price equilibrium, obligating the contractor to procure materials from sources designated by the employer is not only a gross intervention into contractors internal transactions which are commercial by nature but also an intervention in the supply chain. The theory of supply and demand as an organizing principle for explaining how prices coordinate the amounts produced and consumed applies to price and output determination in the market on the condition that no buyers or sellers are large enough to have price-setting power. Market equilibrium occurs where quantity supplied equals quantity demanded at a price below equilibrium, and when there is a shortage of quantity supplied compared to quantity demanded, it poses a price hike-up in the accredited sources more than in the open market. According to Milton Friedman and many other monetarists, market economies are inherently stable if left to themselves. Friedman effectively claims that the social responsibility of business should be to use its resources and engage in activities designed to increase its profits (through) open and free competition without deception. In Adam Smiths view, the ideal economy is a self-functioning market system that automatically satisfies the economic needs of the populace. Smith describes the market mechanism as an invisible hand

that leads all individuals, in pursuit of their own self-interest, to produce the greatest benefit for society as a whole. Demand-and-supply analysis can be used to explain the behaviour of any type of market including construction which is oligopolistic in nature for many cost significant items. An intervention in the supply chain by a major construction client (contributing a considerable proportion of the gross domestic product (GDP) through accreditation) is therefore a serious concern. In a nutshell, large scale procurement through accredited sources can be detrimental in the long run.

Another pitfall in such a mechanism is that the BOQ items with materials supplied by accredited suppliers shall be priced in two different places in the tender document: supply cost to be priced under a separate schedule and all other cost elements under respective BOQ items. This method of pricing Bill of Quantities not only changes the standard way of pricing (inter alia based on pricing preambles) but also makes the evaluation of variations difficult. This is an unnecessary infiltration of the pricing strategies the contractors may employ from project to project on different bases. Duplication of the costing of materials may occur since the cost of a particular material can be included under several bill items, except in a very few cases. Instructing the bidders to be careful about duplication would not suffice. Restricting premature ordering from compensation is another drawback, which is again an intervention in the contractors procurement policy, forgetting the principle of economies of scale which any prudent contractor follows in materials procurement. This restricts the benefits of premature bulk purchases for many forthcoming projects and in line with replenishment of stocks at site level so that the accredited suppliers price may have gone up more than other sources in the market.

Thus, in devising a defect free mechanism, care must be taken not to disturb the freedom of business. For instance, the contractor has the liberty to procure materials from a source of his own choice while the employer also reserves the right to specify the source of procurement in some instances. It is the duty of the contractor, not the employer, to establish the basic prices against the specified materials under specified bill items forming part of the tender. Prices could be ex-factory, imported or open market as the case may be, and it is a pre-tender function of the consultant to specify the materials, compute the input proportions and list them

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in the tender document and verify the base prices with a tender price break-up in support. Care must also be taken in specifying materials eligible for compensation since the use of materials may differ according to the type of project. A reference list of construction material would be in the case of residential building projects of steel, cement, concrete, sand and stone whereas in infrastructure projects it would be of concrete, timber material, sand and stone, bridge columns, expansion joints, asphalt products, drainage pipes, pre-fabricated concrete components, etc. Therefore, price adjustment clauses must be approached with care and should be diligently drafted, specifically identifying the individual building materials most at risk of price fluctuation. The consultant should also check the authenticity of the escalation information as a post-contract function. Also, the consultant must keep records of variances in prices so that a claim for contract price adjustment in a deflation can be made on the employers behalf. Once the price difference has been identified, it shall be a separate claim in its own right.

Contract rates are not subject to change due to price escalation, meaning that the rates shall not be revised depending on the level of fluctuation. Also, a claim on price escalation is separate from a claim for liquidated damages by the employer since a delay in procurement due to delay in progress has a knock-on effect that does not prejudice the contractors eligibility for contract price adjustment on open market price escalation. By the same token, the contractor reserves the right to claim on price escalation even during the extended period/s since he has been permitted to complete the work on a new date.

Equally important is the notification procedure to hold the contractor responsible for notifying the employer of a price increase and its impact on the contract sum

and vice versa. The contractor shall upon the occurrence of any event which may or may be likely to give rise to adjustment of the contract price give notice to the engineer and shall keep such invoices, accounts, documents or records as are necessary to enable adjustment. Also, the contractor shall keep the engineer informed in advance of the procurement of such specified materials at the most economical prices available at the time of purchase to be made compatible with the procurement plan and actual progress.

However, the importance of deciding on an optimum contingency level can not be compromised on the sophistication of the price escalation mechanism in place. Usually being 10% of the total of quoted sums for billed items, a contingency is an allocation for unforeseen events during the currency of works. Price escalation is one such phenomenon where the contingency allocation is used without recalling additional funds. Therefore, it is important to decide on the level of contingency in a rational way as a pre-tender function of the consultants. However, qualitative forecasting methods utilize managerial judgment, experience, intuition, rules of thumb and guesswork so that the decision model is basically implicit and subjective. Trend projection techniques may be appropriate in situations where the consultant is able to infer, from the past behavior of a variable, something about its future impact on inventory, scheduling, seasonal variations and cyclical patterns. Dr. Chandana Jayalath is a Chartered Quantity Surveyor, working in the Middle East. His latest industrial experience is in contract advice, claims review and dispute settlement related to public infrastructure projects. He is the author of Contractual Dimensions in Construction in addition to more than 150 articles published online.

Viking Grain Storage v T H White Installation (1980)

The contract concerned the supply of grain silos. The grain developed mould whilst stored, due to inadequate ventilation.

Held that the defendants were liable for not provideding goods fit for their purpose.

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Sampath Marasinghege, B. Sc Hons (QS)Is a Quantity Surveyor graduated from University of Moratuwa, Sri Lanka in 2002. He is currently working for Damac Properties LLC as a Quantity Surveyor.

Performance security and possible alternative mechanism for performance security in the economic downturn

Introduction

It is common in most present day construction contracts that the contractor is required to provide a performance security in the form of a bank guarantee to the employer upon issue of letter of award as a means of guaranteeing the contractors ability to perform its obligations and the contractors financial viability under the construction contract.

However, due to the impact of the current economic slump, triggered by the financial crisis, which has severely affected the construction industry in the United Arab Emirates (UAE), some small scale (mostly sub contractors) and medium scale contractors are unable to provide performance securities as stipulated in the contract. The main reason for this is that some financial institutes in the UAE, mainly banks, do not provide performance securities during the economic downturn owing to uncertainty building up in the construction industry over the last few years. As a result, employers and contractors have sought possible alternative mechanisms for performance securities in order to overcome such situations and conduct the contract smoothly.

This paper discusses the possible alternative mechanism for performance securities which can be adopted when contractors are unable to provide performance securities and its advantages as well as disadvantages. However, it has to be noted that the contractor shall obtain and provide a performance security (if required) under FIDIC conditions of contract 1987, 4th edition.

What is performance security?

As stated above, performance securities are provided as a useful means of creating financial security for the employer against the contractors failure to perform his contractual obligations. Generally, a performance security is an arrangement under which the performance of one party by another party is assured by a third party.

Performance securities are traditionally categorized as being of two types. The first is what is known as a conditional performance security whereby the guarantor (usually a bank) is only liable to make payment under the security upon proof of the conditions stated in the security. The principal characteristics of conditional performance security are:

1. It is a contract of guarantee whereby the guarantor, i.e., the bank accepts joint and several responsibility for the performance of the contractors obligations under the contract; and

2. The guarantor only becomes liable upon the operation of the proof of a default/breach of the terms of the contract, and the employer (beneficiary) sustaining loss as a result of such default/breach.

The second characteristic is known as an unconditional or on demand performance security where the guarantor is liable to make payment merely upon receipt of a demand for payment from the employer without proof of breach or default by the contractor. These securities exhibit the following characteristics:

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1. It is a pledge by the guarantor, i.e., the bank, to indemnify the employer merely when demand is made upon him by the latter, and

2. It entitles the employer to call upon the guarantor for payment whether or not there has been default under the contract provided only that the call is not fraudulent.

The duration and amount of a guarantee depends upon the terms on which it is given in the contract. Generally, in a FIDIC form of contracts, a performance security remains in force until the contractor has completed the works and remedied any defects.

Furthermore, a performance security is not an insurance policy which normally is a contract of indemnity under which the insured is indemnified in the event of loss, subject to the adequacy of the sum insured. There are also three parties under a performance security (i.e., the contractor, the employer and the guarantor, namely, the bank) as opposed to two under an insurance policy (i.e., the insurer and the insured). Once a performance security is issued, it cannot be cancelled until the stated discharge date or until the subject matter of the indemnity has been completed satisfactorily, whereas an insurance policy can be cancelled before its expiry date with the employer issuing a letter to the bank confirming his consent.

Possible alternative mechanism for performance security

FIDIC forms of contract encourage the contractors to provide performance security in the form agreed by the employer. However, due to the uncertainty building up in the construction industry in the UAE some employers and contractors agree on the need for some alternative mechanism for performance security as guarantors, and that banks or financial institutions do not provide such a performance security.

The following mechanisms are identified as alternatives for performance security currently used in the UAE construction industry:

Additional Retention for Performance Security

Apart from the general retention stipulated in the contract, additional retention money which is equivalent

to the percentage stated in the contract for performance security can be held from each monthly statement as an alternative mechanism for performance security. However, it is obvious that the maximum limit of additional retention should be equivalent to the amount of performance security stated in the contract.

The major disadvantage of this mechanism can be summarized as follows:

1. Performance security retention money is accumulated based on the actual work done and the total amount equivalent to performance security can therefore be retained only after certification of work;

2. Unlike the performance security, there is no financial guarantee from the commencement of the project;

3. It is not possible to retain the total amount equivalent to performance security in the event major work is omitted from the contract;

4. In the event the contractor is unable to perform his contractual obligations during the contract period, the employer does not have an opportunity to make full payment as performance security and the total amount will be limited to the amount of additional retention money; and

5. Holding up the additional retention from contractors monthly statements means that it directly affects their monthly cash flows.

There are some advantages of this mechanism that can be identified as follows:

1. It is not required to pay additional bank charges to obtain and extend (if required) the performance security; and

2. There is an opportunity to invest this additional retention for any other investment from the employer/developers perspective.

w

Accepting a security cheque from the contractor as a performance security is another alternative mechanism currently practiced in the construction industry in UAE. Most main contractors currently obtain security cheques from their subcontractors as a performance security because small scale contractors are unable to obtain traditional performance securities from the financial institutes (i.e., banks) because of their financial position.

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Not only main contractors but also most employers now accept security cheques from their contractors as a performance security owing to the economic downturn. The amount of the security cheque is equivalent to the amount of performance security stated in the contract. Security cheques can be provided as an undated cheque or a dated cheque. However, it has to be noted that the security cheque provided for performance security is a dated cheque. There is a validity period for dated cheques set by the Central Bank of UAE (as per current rules, it is six months from the date of issue) and the dated cheque needs to be re-issued by the contractor prior to its expiry.

The following advantages can be identified in this alternative mechanism for performance security:1. As stated in the aforementioned alternative

mechanism, there are no additional bank charges to obtain security cheques; and

2. Since the amount of security cheque is equivalent to the amount of performance security from the commencement of the project, the employer has an opportunity to make full payment at any stage of the project.

However, there are several disadvantages in this alternative mechanism that can be summarized as follows:

1. Generally, a performance security is an arrangement under which the performance of one party for another party is backed up by a third party. In this alternative mechanism, however, there is no financial guarantee provided by the third party to the first party, i.e., the employer, but the second party. i.e., the contractor provides the guarantee by himself. There is a financial risk to the employer by a dishonoured cheques though contractors provide security cheques;

2. If the security cheque is a dated cheque, it is required to validate the cheque before its expiry;

3. There is a possibility that the contractor may decline to provide dated cheques prior to their expiry at any stage of the project; and

4. Cheques need to comply with the rules and regulations issued by the Central Bank of UAE. Normally, these rules and regulations can be amended by the Central Bank from time to time and employers therefore need to verify the validity of security cheques provided by the contractors.

Conclusion Due to the global economic downturn impacting the construction industry in the UAE, financial institutes (i.e., banks) decline to provide performance securities for some contractors and therefore employers and contractors have sought some alternative mechanism for performance security.

Employers and contractors in the UAE construction industry are testing some alternative mechanisms as discussed above over the last few years. There are several advantages and disadvantages in each mechanism. There is a financial risk to the employer in accepting any alternative mechanism rather than obtaining a performance security in the form of a bank guarantee. Therefore, it is necessary to identify the most suitable alternative mechanism to the contract in the event a traditional performance security cannot be obtained.

As stated above, FIDIC based contracts do not encourage the parties entering into the contract to accept any alternative mechanism for performance security. However, when both parties need to accept any alternative mechanism for performance security, necessary contractual amendments are required to be carefully incorporated into the contract.

Gillies Ramsay Diamond v PJW Enterprices Ltd (2003)

A claim for professional negligence against Diamond, who had provided general consultancy services in relation to a building project, was referred to adjudication. It was found that these services included arranging construction operations for others and/or contract administration and therefore the matter could referred to adjudication, despite the absence of an adjudication clause in the contract.

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S.M. Asanka Sanjaya KumaraBSc (Hons), NCT(QS) Asanka is a Quantity Surveyor graduated from The University of Reading, UK in year 2011. He completed his National Certificate of Technology course in Quantity Surveying at Technical College, Sri Lanka in year 2005. Asanka has worked as a Quantity Surveyor in Sri Lanka, UAE & Morocco during the last decade. He is currently working for Depa Interiors, Dubai, as a Senior Quantity Surveyor.

Why most UAE clients go for Lump Sum building contracts

The United Arab Emirates (UAE) is a constitutional federation of seven emirates (States), which was formally established on December 2, 1971 and one of the most prosperous and politically stable countries in the Middle-East region. The petroleum industry plays an important role in the UAE economy, and a construction boom started during the first decade of the 21st century. It [gifted] a number of large scale construction projects such as shopping malls, manmade islands, new airports, roads, a sophisticated railway transport service, hotels, office buildings, and thousands of residential units including luxury apartments and villas.

Most of the building projects and civil engineering projects started in early 2000 and many of them have been delivered within the first decade. The UAE was a haven for construction people until the industry was hit by the economic crisis that affected most of the countries in the world during the last two years of the decade.

Almost all construction methodologies available in the world were practised during the peak time and some of them were successful while others were not. However, it has been noticed that while most of the building projects in the UAE were constructed under lump sum contracts the civil engineering projects were constructed under re-measurement contracts.

It is emphasized, like in other countries in the world, that the UAE construction industry has faced a greater risk of Time, Cost and Quality of construction projects. During the peak time in the industry, there were many cases reported of the developer/client having sold the building properties even without approved drawings from the local authorities.

Apparently, most of the clients wanted to proceed with

lump sum contracts in the traditional procurement path which was more popular during those days in the market. Theoretically, design should be finalized to get the maximum benefit from a lump sum contract; otherwise, a re-measurement contract is the most appropriate option.

The contractor will have had time to assess the buildability of the project, to organize his supply chain and sub-contractors and generally to have satisfied himself that the job can be completed at a profit, for the contract price and within the contract period. In the UAE, of course, precisely the opposite is usually the case. First, the price and programme are fixed against an outline design, and then a contract of some kind, often just a letter of agreement, is signed. Only after that is the design developed to a level of detail which enables the contractor to see exactly what he has committed himself to. The result, not surprisingly, is a book of variations which quickly runs out of control and a completion date without basis in reality.

The essence of a lump sum contract is that, in return for an agreed firm price, the contractor provides all that is necessary to ensure that the finished plan complies with the contract document and specification, achieves the required levels of performance and is completed on time. The specification, performance requirements and guarantees, and all other technical and commercial contractual conditions must be agreed on in detail before the contract is awarded. Once the contract becomes effective, the lump sum price is payable regardless of the actual cost incurred by the contractor. The contractor must, therefore, include contingencies in his price for estimating errors, uncertainties such as cost escalation and currency fluctuations, the cost of which, on the basis of his experience, will inevitably be incurred from time to time. Such costs arise from design, procurement of

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construction errors, and other unforeseen costs that that the contractor might incur, but has no protection against under the terms of the contract. When considering those contingencies, the eventual cost may turn out to be significantly different from his estimates originally made for the work. The contractor takes the risk that over-expenditure will result in a smaller profit than expected or even a loss, in the knowledge that, if all goes well, his profit may be greater than expected.

Lump sum contracts can be divided into two major parts;i. Lump sum contracts with quantities are based on

drawings and firm Bills of Quantities (BOQ), andii. Lump sum contracts without quantities are usually

based on drawings and specifications together with schedule of work.

Common advantages of lump sum contracts Competitivefairness-alltendersarebasedonexactly

the same information, and there is no interpretation of information.

Costcertainty-thetotalcostisknownattheoutsetof the contract.

Programmecertainty-thetime-frameisestablishedat the outset of the contract.

Wellestablished-thishasbeenthemostcommonlyused route, and everybody knows its pros and cons.

Minorchangesandadaptationsforaspecificprojectare easy to implement with an established method of valuation.

Themethodiscapableofconversiontoaguaranteedmaximumprice(GMP).

Common disadvantages of lump sum contracts Changesaredifficultandcostly. Need tohave substantially completeddesignprior

to bidding. Contractor inclined to choose lowest methods /

materials to comply with specifications. Bidding/Estimation process is expensive and

lengthy. Contractorsmay includehighcontingency for the

rates due to the risk. Limited contractors are sufficiently experienced

to capture the complete scenario of the contract in order to submit a competitive price without compromising the sustainability of the project and contractors organization.

As a result of a recent survey conducted among 111 UAE construction professionals to find out the reason/reasons for selecting lump sum contracts in the UAE building industry, the following were identified:

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Participants were informed to disregard variationsituations during the survey (assumed there are no variations). According to the above Figure 1, 93% of respondents believe cost certainty to be the main reason for the selection of lump sum contracts if there are no variations.

The next two highest percentages of 85% & 83% respectively were received for easy post-contract management (assumed there are no variations) and easy to forecast client cash flow.

Less post contract paper work also a major reason for selecting lump sum contracts if there are no variations.

62% of participants state limited overall project duration and 60% say to achieve faster construction and limited post-contract duration as the other factors.

As per Figure 1, 65% and 62% of participants believe that lump sum contracts will cause post-contract disputes and it is difficult to manage variations. Therefore, handling of post-contract variations has been identified as a key problem of lump sum contracts.

56% of participants think that the clients choose lump sum contracts because of the consultants recommendation.

According to the above table, lump sum contracts are less riskier to the client than re-measurement contracts.

Cost certainty can be expected from a lump sum contract if the design is finalized. All the types of evidence and comments made throughout the survey clearly shows that the UAE clients have chosen lump sum contracts for building projects as a tool for transferring financial risk to the contractor. It is obvious that clients should have cost certainty in price and sell their property in advance as a method of low risk and low cost fund raising.

The clients in the UAE wanted to achieve cost certainty of their projects by using lump sum contract during the last decade, but could not achieve it due to variations that occurred because of improper tender documentation, such as incomplete design and specification. This led to lots of disputes in the industry and many cases have ended up with unexpected cost overruns.

Risk allocation between the client & the contractor in different procurement routes (Figure 2)(Takashi Saito,1999)

References

1. Skaik,Samer.2008.UAE:TimeforGMPcontracting?.http://www.cmguide.org/archives/2362. Saito,Takashi.1999.The characteristics of Japanese construction procurement by the risk management approach. London: Cobra 1999-RICS

Research.

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C. J. QuicksonBSc (Hons), LLM (Constr. Law & Arb) , AAIQS, MRICS, CCE, MCIArb

Letter of Intent (LoI) and its importance in the construction industry

1.1. Introduction to Letter of intent and its legal aspect

It is a fact of modern building contracting that a significant number of both main and sub contracts are let under a letter of intent; the intention being to conclude a written contract shortly afterwards. Letters of intent are not confined to the construction and engineering industries. However, most of the reported and unreported cases concern those industries and so for convenience the terms Employer and Contractor are used below.

In the present context, the term Letter of Intent is used to describe a letter from the Employer to the Contractor which includes the following elements:

a. The Employer indicates an intention to enter into a formal, written contract with the Contractor for the Contractor to carry out the work described in the letter of intent.

b. The Employer requests the Contractor to start work at once or at any rate before the parties execute the formal, written contract.

However, the expression is not a term of art. This was held in the leading case of ERDC Group Limited v Brunel University where HHJ Humphrey Lloyd QC stated about the letter of intent as follows:

Letters of intent come in all sorts of forms. Some are merely expressions of hope; others are firmer but make it clear that no legal consequences ensue; others presage a contract and may be tantamount to an agreement subject to contract; others are contracts falling short of the full-blown contract that is contemplated; others are in reality that contract in all but name. There can therefore be no prior assumptions, such as looking to see

if words such as letter of intent have or have not been used. The phrase letter of intent is not a term of art. Its meaning and effect depend on the circumstances of the case.

Pending the execution of the formal, written contract, a Letter of Intent containing the two elements identified above will normally take effect in one of three ways as described below under types of Letter of Intent in use Types (a), (b) & (c).

For all practical purposes, where the Letter of Intent results in a contract which incorporates the conditions of the FIDIC, JCT or other standard form referred to in the Letter of Intent, it will make little difference whether the Letter of Intent is analysed as falling into type (b) or type (c). What matters is whether the conditions are incorporated or not under the above types.

Therefore, the types of Letter of Intent can be reclassified as follows, which will help to discuss further in detail the LoI under the following categories.

Type (a) A pure letter of Intent: As a request by the Employer to the Contractor which, if actioned by the Contractor, entitles the Contractor to a restitutionary remedy, namely, payment of a reasonable sum (a quantum meruit) for the value of any work done or any materials supplied. Type (b)A letter of intent incorporating interim contractual arrangements: As a request by the Employer to the Contractor, which if actioned by the Contractor, creates an interim contract between the parties on terms that fall short of the terms and conditions of the relevant standard form.

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Type (c)A letter of interim sufficient to form a contract for the entire project: As a request by the Employer to the Contractor, which, if actioned by the Contractor, creates an interim contract between the parties on most or all of the terms and conditions of the relevant standard form

OR

As a final contract between the parties incorporating the terms and conditions of the formal, written contract notwithstanding the failure of the parties to execute the formal, written contract.

Dividing the Letters of Intent into the above three categories will depend on the intention of the parties, which is found by an objective interpretation of:

a. The language of the Letter of Intentb. The surrounding circumstances, including anything

the parties wrote, said or did subsequent to the Letter of Intent.

1.2. Critical analyse of its impact on disputes aroused from letters of intent

This section will provide, how the decisions made by judges from the cases in the past years due to the disputes arouse from the letters of intents, under the above 3 types, as discussed in the previous section.

Through these discussions, it will be easy to get the feedback and results of how the parties drafted the Letter of Intent in the past years and how it had been interpreted by the parties.

a. Cases classified under Type (a)The court prefers to avoid putting a Letter of Intent into this type at all. Where a letter of intent authorises work, materials or services to be provided pending the conclusion of some further agreement and the letter is accepted, the court will try to establish a contract for that which the letter requires since that would be consistent

with the parties presumed expectations. In the case of Durabella Ltd v J Jarvis & Sons Ltd1 where Judge HHJ Humphrey Lloyd QC held that It is in my judgment clear that Jarvis intended that its formal order was being postponed solely so that it could record the results of the survey and measurement, i.e., the quantity to be paid for at the agreed rate.

However, a contract cannot exist unless it is clear that, viewed objectively, the parties were in fact agreed on all the matters which they considered necessary and which are necessary to form a contract.

Further in the case of Trentham (G Percy) Ltd v Archital Luxfer Ltd2, where Steyn LJ said in an often quoted dictum that the fact that a transaction is performed on both sides will often make it unrealistic to argue that there was no intention to enter into a contract. However, Steyn LJ went on to state that the position might be different where there was an express provision in a letter that there was to be no contract at all until the occurrence of a particular event, such as the execution of a formal contract.

In the case of Jarvis Interiors Ltd v Galliard Homes3, where Lindsay J (with Schiemann LJ and Evans LJ agreed) noted the broad disposition to find a contract if one can.

However, in some cases the terms of the Letter of Intent and/or the facts may be inconsistent with an intention to enter into any contract at all. Which of these types fall under this category Type (a)? An example is British Steel v Cleveland Bridge, 4where it was held that there was no if contract when, in a case such as the present one, the parties were still in the state of negotiation.

The case of Jarvis Interiors Ltd v Galliard Homes5 is a more recent example. The Court of Appeal found that in the absence of a contract under seal, there was no contract at all. Note, however, that Galliard did not advance the argument that the Letter of Intent, when acted on, created a contract Evans LJ clearly thought this argument would have succeeded.

1 Durabella Ltd v J Jarvis & Sons Ltd (2001)83 Con LR 1452 Trentham (G Percy) Ltd v Archital Luxfer Ltd[1993] L Lloyds Rep 25at page 273 Jarvis Interiors Ltd v Galliard Homes [2000] BLR 33 (CA)4 British Steel v Cleveland Bridge 24 BLR 945 Jarvis Interiors Ltd v Galliard Homes [2000] BLR 33

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As discussed above, where the cases fall into Type (a), the effect of the Letter of Intent is to authorize the Contractor to carry out the work. However, the Contractor will be entitled to stop work at any time without notice.

Similarly, the Employer will be entitled to instruct the Contractor to stop work at any time without notice. Similarly, in the absence of a contract, the Employer will not be able to counterclaim for breach of contract, e.g., for the cost of defective work. However, it seems that the defects can be taken into account when assessing what the work is worth as decided in the case of British Steel v Cleveland Bridge6 24 BLR 94

b. Cases classified under Type (b)Under this category, it was held by HHJ Thornton QC in the case of Hall & Towse South Ltd v Ivory Gate Ltd7, where he stated that by starting work Hall & Towse accepted the offer contained in the Letter of Intent resulting in a provisional contract. The contract was a bilateral one that required Hall & Towse to complete the works in a reasonable time for a reasonable sum. As far as reasonably possible, valuations were to be carried out in accordance with the JCT provisions referred to in the Letter of Intent.

In Mowlem PLC (trading as Mowlem marine) v Stena Line Ports Ltd8 it was common ground that each Letter of Intent in a series created an interim contract which superseded each earlier contract. Each Letter of Intent imposed a cap on the amount which the Employer would be liable to pay. The Employer argued that this was simply an if contract with the result that the Contractor was entitled to stop work at any time. The issue was whether the Contractor was entitled to be paid a reasonable sum in excess of the cap for work he carried out which, he said, exceeded the value of the cap. HHJ Richard Seymour QC held that all the work was subject to the final interim contract and so the cap applied to it.

The initial contract in Westminster Building Co Ltd v Beckingham9 was an if contract, where there was a

simple contract between the parties created by the Letter of Intent, which provided that such work as was carried out in accordance with the specification and the drawings would be remunerated on a quantum meruit basis.

Hall v Towse South Ltd v Ivory Gate Ltd10 and ERDC Group Ltd v Brunel University (TCC), HHJ Humphrey Lloyd QC, 29th March 2006 are further examples of cases where the court found a bilateral contract whose terms fell short of the intended bilateral contract.

In the case of Hackwood Ltd v Areen Design Services Ltd11, Field J held that when the Letter of Intent was construed against the background of the surrounding circumstances, it was the intention of the parties to enter into an interim contract incorporating all the JCT terms and conditions save to the extent that those terms were inconsistent with the terms of the letter.

Cases classified under Type (c)In this Category, the proper conclusion is that the parties intended to contract on the full terms of the intended contract referred to in the Letter of Intent notwithstanding that they never in fact executed a formal written contract. Depending on the facts, in particular on the precise language of the Letter of Intent, this may result either in a conclusion that the parties entered into an Interim Contract pending execution of the formal contract or that there was a Final Contract because the parties expressly or impliedly dispensed with the requirement for the execution of a formal contract.

In the case of Harvey Shopfitters Limited12 v ADI Limited , the crucial phrase in the Letter of Intent was If, for any unforeseen reason, the contract should fail to proceed and be formalised, then any reasonable expenditure incurred by you in connection with the above will be reimbursed on a quantum meruit basis. Harvey argued that this meant the parties intended the contract should be formalised by formal contract documents being signed, in the absence of which Harvey was entitled to a quantum meruit. The Court of Appeal rejected this argument. The

6 British Steel v Cleveland Bridge 24 BLR 947 Hall & Towse South Ltd v Ivory Gate Ltd (1997) 62 Con LR 1178 Mowlem PLC (trading as Mowlem marine) v Stena Line Ports Ltd [2004]EWHC 22069 Westminster Building Co Ltd v Beckingham [2004]EWHC 138 (TCC)10 Hall v Towse South Ltd v Ivory Gate Ltd (1997) 62 Con LR 11711 Hackwood Ltd v Areen Design Services Ltd [2005] EWHC 2322 (TCC)12 Harvey Shopfitters Limited v ADI Limited 2003] EWCA Civ 1757

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Court of Appeal found that the words meant that the only circumstance in which Harvey would be entitled to a quantum meruit was if the contract did not proceed and was not finalised. The contract did proceed and so Harvey was not entitled to a quantum meruit.

Allen Wilson Shopfitters v Buckingham13 is another case where HHJ Coulson QC concluded that the signing and returning of the Letter of Intent by the contractor led to a contract incorporating the JCT conditions referred to in the Letter of Intent.

SummaryAs discussed above under 3 Types, the more recent cases show that the court is inclined to find a contract if it can (at least in construction/engineering cases) since the court believes this will usually accord with the intention of the parties (Hall & Towse v Ivory Gate, Durabella v Jarvis, Jarvis v Galliard).

However, when the Letter of Intent and the surrounding circumstances show that the parties were continuing to negotiate about matters that were or that they regarded as essential to the existence of a contractual relationship between them, there will be no contract (Durabella v Jarvis; British Steel v Cleveland Bridge4). The same will be true if the Letter of Intent expressly states that there will be no contract between the parties until the occurrence of a stated event and that event does not occur or if the Letter of Intent contains some other express term negativing the existence of a contract (dictum of Steyn LJ in Trentham v Archital; Jarvis v Galliard).

As discussed above, we can come to a conclusion based on the cases as follows, how the court / judge will interpret and act based on the terms, wordings and intention of the parties used in the Letter of Intent.

The court is well aware that in the construction industry the parties all too often simply fail to get round to executing a formal contract incorporating the terms of a standard form the parties contemplated should govern their relations.

As in Type (b), where the Letter of Intent indicates an intention to enter into a contract on a standard form, where the contractor starts work on the basis of the letter

and where all that is outstanding is the execution of the written form, then the court is likely to conclude:(i) The parties entered into a bilateral contract (final or

perhaps interim).(ii) The contract incorporated the terms of the standard

form as discussed above under the case of Harvey Shopfitters v ADI, Westminster Building v Beckingham and Allen Wilson v Buckingham.

The following factors are, [without more,?] unlikely to lead to the opposite conclusion:(i) The absence of an executed contract (Hackwood v

Areen; Westminster Building v Beckingham; Harvey Shopfitters v ADI; Allen Wilson v Buckingham).

(ii) The use of the future tense in the letter of intent (Hackwood v Areen).

(iii) The fact that the parties continue to negotiate about those terms of the final contract (Hackwood v Areen) that the court regards as immaterial.

(iv) The absence of agreement on points the court regards as immaterial.

Also, under Type (c) where the Letter of Intent indicates an intention to enter into a contract on a standard form, where the contractor starts work on the basis of the letter and where the parties do not execute the written form, one or more of the following factors may lead to the conclusion that the parties entered into either an interim bilateral contract, but one which did not incorporate the terms of the relevant standard form, or a simple interim unilateral contract:

a. An absence of agreement on all the matters which the parties considered necessary and which were necessary to form a final contract: Durabella v Jarvis. Such a failure may result in the conclusion that there wasnt a contract at all.

b. The fact that the parties continue actively to negotiate about material matters such as the scope of the work and materials to be supplied, the date for completion, the price, etc. In some circumstances, such negotiations may also indicate the absence of any intention to contract at all, as in British Steel v Cleveland Bridge.

c. The language in the Letter of Intent which is inconsistent with the incorporation of the terms of the standard form or which makes it clear that

13 Allen Wilson Shopfitters v Buckingham [2005] EWHC 1165 (TCC)

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pending something further happening, there is a simple unilateral right to be paid for work done. For example, an express provision that pending the execution of the formal contract, the Contractor is to be paid a reasonable sum for the work executed and the Employer is entitled to terminate the Work at any stage. In some circumstances, however, such a provision may prevent a contract arising. Or language that makes it clear the Contractor is instructed to commence only a limited amount of work (Eugena v Gelande14 where the judge stated that as far as the works not covered by the language of Letter were concerned, Eugena was not entitled to payment: there was no express or implied term in the Letter providing for payment and there was no express or implied request for Eugena to carry out the work which would found a claim for a quantum meruit)

Where the proper conclusion is that there is a bilateral Interim Contract, but one which does not incorporate all the terms of the standard form referred to in the Letter of Intent, it seems the court is likely to be ready to conclude that any relevant terms were incorporated subject to evidence of a contrary intention, as discussed above in the cases Hall & Towse v Ivory Gate; Hackwood v Areen.

Where the Letter of Intent results in an Interim Contract or Contracts for only part of the Works:

(i) The Contractor will be entitled to the payment at the agreed rates for that part of the Works.

(ii) Where the Contractor carries out additional work, the question of what further payment, if any, he will be entitled to will depend on the circumstances.

a. Where a Contractor carries out the additional work

at the Employers request, the normal inference is that the parties intend the Employer shall pay the Contractor a reasonable sum for it (Latchlin v General Med15 Jacob LJ giving the judgment of the Court said In the absence of any other facts, the giving to, and carrying out of, instructions by a professional normally gives rise to an implied promise to pay because no other explanation of those facts makes commercial sense necessity compels the conclusion).

b. Where, however, the Letter of Intent places a cap on the amount of the Employers liability, the Contractor will not be entitled to further payment above the cap, subject to the Employer being barred from relying on the cap by waiver, estoppels, etc. (Mowlem v Stena; Eugena v Gelande).

c. However, when the letter is properly construed it, the cap may be ineffective (AC Controls v BBC , where HHJ Thornton QC concluded that when the detailed provisions of the Letter of Intent were properly construed, the financial limit did not apply and ACC was entitled to claim the full value of the work it had carried out.

(iii) The other rights and obligations of the parties will depend on the terms of the Interim Contract (Eugena v Gelande).

As a conclusion and as per the critical evaluation with the case laws under above 3 Types, it is vital that Type (c) [will fulfil in both cases, Neither, the parties are forming the formal contract nor the parties are not forming the formal contract.?] Therefore, the LoI in Type (c) will diminish and avoid the possibilities of disputes arising between the parties, but it depends on the proper drafting of a LOI.My next article as a continuation of this will focus on the requirements of a LOI to form a binding agreement.

14 Eugena v Gelande [2004] EWHC 3273 (QB),15 Latchin v (1) General Mediterranean Holdings SA (2) Mr. Auchi [2003] EWCA Civ 1786.

Sauter Automation Ltd v Goodman (Mechanical Services) Ltd (1840)

A sub-contractors quotation was expressed as subject to our standard terms and conditions which included a retention of title clause. The main Contractor sent an order stating terms and conditions in accordance with the main contract. The Sub-contractor, without further communication, delivered the goods.

Held that this amounted to an acceptance by them of the main Contractors counter offer.

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Internal Auditors are at Site!

After a comfortable period during a construction boom, we are now in a recession. Everyone is pinching every penny. Owners are looking for the reasons for mistakes made in the past. Managements are keen to monitor day-to-day activities of their employees closely. Thus, the auditors are now at site!

The Quantity Surveyor is the most important member of the construction project team, from the perspective of the auditors. Why?

1. He has the most historical records.2. He is responsible for the money spent on the project. 3. He is the commercial and contractual advisor to the

client.4. He is the last member of the project team to leave.

Hence, the Quantity Surveyor has to be prepared to face audit queries at regular intervals. How does he prepare to face them?

What is an internal audit? Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organizations operations. It helps an organization accomplish objectives by using a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes.

What are internal auditors looking for?

Internal Controls What do you know about internal controls which are applicable to your scope of work? There are five interrelated components in internal controls: Theorganizationsoperatingenvironment Goals,objectivesandrelatedriskassessments

Controlsandrelatedpoliciesandprocedures Informationsystemsandcommunicationmethods Activitiestomonitorperformance

An effective control system provides reasonable, but not absolute assurance for the safeguarding of assets, the reliability of financial information, and compliance with laws and regulations. Reasonable assurance is a concept that acknowledges that control systems should be developed and implemented to provide management with the appropriate balance between the risks in a certain business practice and the level of control required to ensure business objectives are met. The cost of control should not exceed the benefit to be derived from it. The degree of control employed is a matter of good business judgment.

In a project audit, what kind of controls would internal auditors like to see?

1. Financial reconciliation2. Shared savings calculations3. Contingency, allowances, credits4. Closeout reporting

Policies and Procedures Internal auditors follow a guideline in connection with the companys policies and procedures. If your office is about to be audited, you should be able to understand the procedures and processes established in the company. Most leading companies have well documented procedures and processes that are easily accessible to all employees. You should be able to read and understand the areas relevant to your scope. If anything is not clear, it is managements responsibility to explain to you. So please be clear.

Saman Jayasiri Sirisoma WelagedaraBSC (Hons) , MRICSInternal Audit ManagerDubaiPropertiesGroupDubai

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Be aware, however, that if something is not in the approved procedures or processes, it is the operation teams responsibility to bring such activities to managements attention to take the appropriate measures. Otherwise, auditors will look for best practices, which will be subjective and debatable. It shall be in your individual interest to have a comprehensive procedure in your duties. Internal auditors would like to see what you have done to reach your conclusion where debatable issues are involved. Take additional care in documenting the process you have followed (whether approved or not). Now, where are you? You do everything stated above in your day-to-day duties. An internal auditor is looking for whether you are well aware of internal controls and they are adequately applied. How do you apply internal controls to your day-to-day business?

1. Risk assessment

Modern internal audits are mainly based on risks. Your project will be audited based on a risk assessment done by internal auditors. If your department has a risk assessment process, internal auditors will request a copy of the risk register maintained by you. An updated risk register would make things easy and it will be a good approach towards a successful audit from your point of view. Internal auditors consider management to be nonexistent without risk management.

2. Be within your limits and check others also

Most companies have their approved Delegation of Authority (DOA) in place. Keep a copy with you at all times. When you draft an internal approval request or a variation order, check the DOA. Make sure that you are signing for something within your limits. Check other signatures for the same. If you find any exception, report to your manager immediately. Violation of DOA will be a serious concern to internal auditors because overriding ones own procedures is the biggest violation in a business.

3. Keep tracking

All your activities are related to a process. A payment

certificate would come to your table after passing a number of stations. In the same way it will go to more tables to complete its process. Sometimes, you are responsible for the overall time taken for the process! So how do you track your documents? How do you control meeting your deadlines? Be smart and enter all critical documents, such as payment certificates, variation orders, draft internal approvals, etc. in a tracking system. Add a pop up mechanism to remind you to follow up. Internal auditors are concerned about delays!

When is the Contractors All Risk insurance expiring? Did you send a reminder to the contractor? Include all insurance policies in the tracking system. Then you are managing insurances, not merelykeeping records!

4. Keep records of communication

You are dealing with various stakeholders of the company and external customers. Every transaction you make may be important to the company. Keep records of communications, especially those related to critical transactions. Letters, e-mails, reports, presentations, memos, etc. are important to track your dealings. They would also help you safeguard yourself. Request others to confirm any verbal communication by e-mail or letter whenever you feel it important to do so. Never take action on verbal communications unless confirmed in writing!

You may engage in negotiations to finalize a claim. Make sure to document every negotiation step. You will be the person who is responsible for drafting the final agreement. Internal Audit would request you to provide documented negotiation records. Attend the commercial meetings regularly. It is one of your basic responsibilities. Take notes in the meeting and compare them with the minutes of meetings. Never agree to something not discussed and agreed on!

5. Be wise in justifications

You are the commercial judge in a construction project which is exposed to a huge number of variations. Most of these variations would cause additional costs to the client. Hence you should be able to give proper justification for the variations.

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The common reason that It was not in the contract may not be sufficient for internal auditors. They may be interested in determining why it was not in the contract. Be ready for such questions.

Your internal approval form should be able to provide the story of the variation or claim. Internal auditors like to read the history: How did this happen? Who initiated it? How did you select the best option? Did we get the best market price? Why are there no cost savings? etc., etc. Internal auditors would like to see the best practices in place in the finalization of claims! Three quotations may not be practical at all times, but try to be reasonable to convince the auditors. Well-justified variations of claims will not be questioned!

6. Do reconciliations regularly

What is the net position of the contractors accounts? How much retention money has to be released? How much do you have to recover from advance payments? What are the back charges? Are you confident about all adjustments? Discounts? When did you update your records? Internal auditors are looking for a clear picture of accounts. An updated reconciliation would save time for auditors as well as the auditee!

7. Be proactive in mitigation of losses

Mitigation actions to avoid or reduce losses are expected from every employee of the company. Whether it is within your scope or not, at least the minimum possible effort needs to be expended in the vicinity of a