International Contractor Groups Raise Concerns

The presentation by FIDIC at the Users conference in London in December 2016 of its pre-release version of the Yellow Book Second Edition 2017 provoked a number of reactions. Many contractors and those bodies representing contractors were concerned about several issues, especially the new proposed clause 17.

In fact, so concerned were international contractor groups that a number of them (including, amongst others, the Confederation of International Contractors’ Association, the European International Contractors, and the International Contractors Association of Korea) sent a joint letter to FIDIC highlighting their particular concerns.

Clause 17.7 – New Contractor Indemnity

So what was it about the pre-release version that concerned international contractors so much? The main controversy was in relation to the changes made to the Indemnities and Limitations on Liability wording. The contractor’s indemnities under the new Yellow Book (in new clause 17.7) reflect the position previously included within clause 17.1 of the First Edition but with the following additional provision:

“The Contractor shall also indemnify and hold harmless the Employer against all error in the Contractor’s design of the Works and other professional services which result in the Works not being fit for the purpose(s) intended in accordance with Sub-Clause 4.1 [Contractor’s General Obligations] or result in any loss and/or damage for the Employer (including legal fees and expenses).”

The wording introduces a new indemnity in relation to design breaches and breaches of fitness for purpose. Effectively this new indemnity wording potentially exposes the contractor to wider-ranging losses and increased limitation periods. As if this were not controversial enough, FIDIC’s associated changes to the Limitation of Liability provisions (clause 17.6), as explained further below, have compounded the misery for contractors.

Clause 17.6 – Limitation of Liability Revised

The pre-release version of the Yellow Book introduces two key changes linked to the new contractor indemnity. The first relates to the following wording:

“Neither Party shall be liable to the other Party for loss of use of any Works, loss of profit, loss of any contract or for any indirect or consequential loss or damage which may be suffered by the other Party in connection with the Contract, other than under:

. . .

(d) Sub-Clause 17.7 [Indemnities by Contractor]. . .”

This is a new carve-out. The effect of this provision is that any fitness for purpose claims and some design breaches will expose contractors to increased liability by virtue of the fact that employers would now be entitled to claim for indirect and consequential losses.

To make matters worse, the contractor’s liability under the new indemnity is unlimited as the following wording expressly carves out the indemnity under clause 17.6 from the overall cap on liability:

“The total liability of the Contractor to the Employer under or in connection with the Contract, other than:

(i). . .

(ii) under Sub-Clause 17.7 [Indemnities by Contractor], and . . .

shall not exceed the sum stated in the Contract Data or (if a sum is not so stated) the Accepted Contract Amount.”

Rightly Concerned

Contractors are therefore, quite rightly, concerned about having to sign up to what would effectively be an unlimited liability for certain design breaches and fitness for purpose, not only unrestricted as to the type of losses that may be recoverable but also unlimited as to the overall liability for any such claims.

Rationale?

FIDIC have not offered any explanation or reasoning behind this proposed new provision. Some legal commentators have speculated that the wording may have been introduced to deal with what would otherwise be a contradiction with clause 11.4(d) of the pre-release edition (which is similar in content to clause 11.4(c) of the First Edition). Under this clause the Employer has the right to terminate the contract if the Contractor fails to remedy a defect or damage if such defect or damage deprives the Employer of substantially the whole benefit of the works. The Employer is then entitled to recover from the Contractor all sums paid for the Works plus finance charges and cost of dismantling.

Given how rarely employers exercise the right under this clause, the new indemnity provision would appear to be disproportionate. Surely there must be another way of dealing with such contradiction, if in fact this was FIDIC’s reasoning behind the new indemnity wording.

Need for Caps on Liability

From a commercial perspective, a total cap on liability is the best way for a contractor to limit its total exposure. The level at which that cap is set is a matter of agreement between the parties, dependent upon the commercial risk profiles of the parties. Accordingly, having agreed a total cap on liability, contractors will want there to be as few “carve-outs” from this total cap as possible. There are obviously certain types of claims that cannot be excluded or limited by law; for example, under English law, claims in relation to death or personal injury cannot be limited. Then there are other carve-outs that are commonly acceptable on the basis that such losses are generally insurable, for example claims for damage to third party property.

However, it appears unreasonable to expect the consequences of design defects to fall outside the cap on liability. This is especially so when design defects are likely to form a substantial part of any claim by an Employer, but also because of the difficulties associated with obtaining insurance coverage for fitness for purpose design obligations.

What Next?

Having heard the concerns raised, FIDIC have agreed that it will look at the indemnity wording again. So it remains to be seen whether the new indemnity wording will survive in its current form when the Second Edition is finally issued later this year. Contractors will certainly be hoping not.