Clients who ask us to help them draft forms of guaranteed maximum price (GMP) contracts, have a variety of reasons for their decision to contract on this basis. Fixed price lump sum contracting, they point out, assumes that the design will be more or less complete at the time the contract is signed. The Contractor will have had time to assess the “buildability” of the project, to organise 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 time.
In the UAE, of course, precisely the opposite is usually the case.
First, the price and programme are fixed against an outline
design, then a contract of some kind – often just a letter
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.
There are signs that the UAE’s major developers are starting to
realise that they can’t have it both ways. Fixed price and fixed
time mean fixed workscope. If, on the other hand, an instant
start on site really is essential, with construction following hard
on the heels of design development, a procurement method
which is more flexible than the rigid fixed price lump sum
approach is needed.
For these reasons, the UAE’s construction industry is seeing
increasing numbers of contracts awarded on the basis of a
GMP. The advantage of GMP contracting, if properly used,
is that it facilitates an early start on site without sacrificing
reasonable price certainty. It incentivises the Contractor to
be efficient and the Developer to ensure that his design team
sticks to the design development programme.
So, how does GMP contracting work? Typically, the Contractor
bids against the Developer’s preliminary or outline design and
specification and the parties agree a guaranteed maximum
price. Interim payment valuations are made on an actual
cost, open-book basis. The categories of reimbursable costs
– labour, materials, plant and sub-contractors – are preagreed.
There is a fee, either a lump sum or a percentage
of the reimbursable cost, to compensate the Contractor for
overheads, profit and preliminaries. As the design develops,
often with the benefit of the Contractor’s suggestions on
buildability, the GMP remains fixed, subject only to adjustment
in case of major scope or design concept changes, or the usual
Employer’s risk events.
The incentives usually arise by agreement of a “target cost”
– sometimes an evolution of the GMP agreed between the
parties when the design has become sufficiently frozen. In
other words, once the design target is no longer moving, the
target cost can be fixed.
The target cost will work in conjunction with a pain/gain share
regime. So, if actual cost is lower than target cost, the cost
saving is shared on a pre-agreed percentage basis. If on the
other hand actual cost exceeds target cost, the cost overrun is
only shared between by the Developer and the Contractor to
the extent of the pre-agreed percentage, with the Contractor
retaining the risk of all cost overruns above the GMP.
The advantages are obvious. In order to earn their shares of
the cost savings or minimise their shares of the cost overruns,
both parties will need competent project management,
efficient design development and drawing issue, tight subcontract
procurement and supply chain management and
elimination of waste.
So much for the underlying principles: what about the
practice? Some alarming consequences have resulted from
the unshakeable belief, still widespread in the UAE, that any
construction contract should be drafted using the FIDIC Red
Book (4th Edition) as its basis. A quick glance should satisfy
even FIDIC’s most loyal users that it cannot easily be adapted
for use as a GMP/cost reimbursable/target cost contract.
A number of suitable standard form contracts have been
published. These include the UK’s JCT Prime Cost contract, the
NEC Option C, D and E and the ICHEME Green form but none
of these seems yet to have found favour in the UAE.
You should, therefore, consider using one of these forms as
the basis for your GMP/target cost contract, rather than FIDIC.
Or, if you decide to go bespoke remember you will need a
contract which covers at least the following:
• a way of fixing the target cost (if not already fixed in the
contract);
• the criteria for adjusting the GMP and/or the target cost
and a procedure for agreeing or fixing those adjustments;
• what will constitute changes in the original scope, sufficient
to justify increases in the GMP and/or target cost?
• the admissible categories of reimbursable costs;
• how is the fee calculated and what does it include and
exclude?
• which cost components are fixed at the date of the
contract and which are subject to escalation?
• how will the advance payment, if any, be apportioned
between cost and fee?
• what compensation is payable upon termination? …and so
on.
To conclude: GMP/target cost arrangements may be part of
the answer to the time/cost/scope tensions which are part
and parcel of the UAE’s fast-track mentality. These contracts
can be written simply and clearly but FIDIC, particularly the
modified version of the FIDIC Red Book (4th Edition) which is
still widely used in the UAE, is not the place to start.