Guaranteed maximum prices: Berth pangs

The Technology and Construction Court recently examined a guaranteed maximum price provision in the case of AMEC Group Ltd vs Secretary of State for Defence. This was contained in a contract for the construction of a submarine berthing facility at HMNB Clyde, in Scotland.

A guaranteed maximum price (GMP) is a pricing mechanism associated with target cost contracts. These agreements are often used when the project cost cannot be forecast accurately, perhaps because design development is incomplete or because it is not possible to quantify all major risks before works commence. The contractor will instead be paid the actual costs it incurs, plus a fee.

Some clients are uncomfortable with open-ended costs, so the parties can also agree a GMP as a ceiling on liability. Should costs exceed this cap the contractor bears the overrun.

However, if it finds savings, the contractor can reap the financial rewards. It’s easy to see then how GMP arrangements can appeal.

The client achieves price certainty while the contractor is incentivised for efficiencies.

In certain circumstances a client can end up paying more than the GMP. These include where there are instructed variations and acts of client prevention.

While GMP mechanisms are common, no standard form contract offers wording. Provisions are consequently bespoke and it was the drafting used that came under scrutiny in this case.

Here the original GMP was set at £89m. This had since been adjusted to £142m with the total cost being likely to balloon to £235m. The contract’s pricing mechanism should have clearly set out how the overspend would be apportioned. Unfortunately, as Mr Justice Coulson summed up, the agreement, as set out in the contract, was “unusual” and “badly-worded”.

Unfortunately, as Mr Justice Coulson summed up, the agreement set out in the contract was ‘unusual’ and ‘badly-worded’

There was no dispute that the first £50m of overrun above the GMP was to be borne by AMEC, the prime contractor. Over this sum, however, liability would revert back to the employer. Things then became murkier. Clause 9.2.6 stated that, up to reaching the GMP, the parties would split the difference between the target cost and actual cost. AMEC would then be liable for all costs in discharging its obligations, subject to the £50m cap. Above this level, the drafting left doubt as to whether the employer’s liability was to reimburse all AMEC’s costs or only its actual costs. This was a major distinction since the latter were recoverable only if reasonably and properly incurred.

It was not ultimately necessary for the learned judge to rule on the adequacy of the drafting. The dispute over the cost overrun had previously been referred to an adjudicator whose interpretation was that the employer’s liability was for actual costs.

AMEC subsequently referred the same issue to a disputes review board constituted as an arbitration panel of three eminent lawyers. The majority agreed with the adjudicator. One dissented.

TheTechnology and Construction Court heard AMEC’s appeal of the arbitrators’ award, on the argument that they had erred on a point of law under section 69 of the Arbitration Act 1996. This is a difficult test to pass and the court was not sufficiently persuaded. AMEC’s challenge was rejected.

While the judgment does not change the law, it emphasises the difficulties with drafting GMPs, particularly those involving complex pain/gain share elements. It is clear that, if the requisite contract provisions are not expressed in unambiguous terms, even distinguished lawyers will struggle to discern their true meaning.

The full details of the arbitrators’ award are left unrevealed (reflecting the confidential nature of arbitral proceedings) but we are made privy to select morsels. These include the dissenting arbitrator’s supposition
that the client’s willingness to be liable for costs over £50m must have been either to protect it from AMEC being unable financially to complete the project or to give comfort to AMEC’s bankers that its losses would not be limitless.

The majority view took the more conventional approach of analysing other contractual provisions to establish what had been intended by the parties.

Francis Ho is a senior associate at Olswang