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time. It can therefore involve valuation on the challenging basis of what might have occurred under a hypothetical situation.
In view of all of the above, the final valuation rule at clause 63.14 is of some interest. It provides for the project manager and contractor, if they agree, to use rates and lump sums to assesses compensation events instead of defined cost.
15.4FLUCTUATIONS
We may now look briefly at fluctuations, which are the third mechanism by which the contract sum may validly be adjusted. The purpose of a fluctuations clause is to provide a mechanism for reimbursing contractors for changes in input prices over which they have no control at all. Even if a contractor has caused the project to take longer than planned, the changes in market prices for supplies will be caught by a valid fluctuations clause, unless the clause expressly provides otherwise.8 Both JCT SBC 11 and ICC 11 specifically provide that a contractor who is in delay shall not benefit from the fluctuations clause. The contract particulars must state which of the fluctuations clauses apply.
In JCT SBC 11, clause 4.21 simply brings into operation the fluctuations clauses. It does this by stating that fluctuations shall be dealt with according to whichever of three alternatives are identified in the contract particulars. These alternatives are clauses referred to as Options A, B and C. In the absence of any entry in the appendix, the basic minimum provision for fluctuations contained in Option A is stated to apply. The three fluctuation schemes are as follows:
Option A: Contributions, levy and tax fluctuations. This clause applies to items which are affected by the government and are thus completely beyond both the control and the prediction of the contractor. The elements to which the clause applies are labour, materials and goods, electricity and fuels, but only to the extent that they are affected by tax etc. In some cases they are only covered as far as they have been listed in the contract documents. There are no methods for calculation set out in the clause, but obviously it would be necessary to take into account man-hours, quantities of materials and other directly ascertained costs. It is not intended that this clause should change the amount of contractor’s profit.
Option B: Labour and materials cost and tax fluctuations. This clause includes all the government-related items that are covered by Option A; it adds in labour and materials fluctuations. This covers the market costs of input, such as wage rates and prices of materials.
Option C: Use of price adjustment formulae. This is a completely different type of calculation. It incorporates by reference a set of formula rules which define a technical financial calculation based on a wide variety of categories. The whole of the works is divided up into financial categories and a monthly published bulletin gives indices by which each sum should be multiplied. In order for this to work, it is necessary for the contract bills to reflect the categories used by the fluctuation categories. Since the index
8 Peak Construction (Liverpool) Ltd v McKinney Foundations Ltd (1970) 1 BLR 111.
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numbers reflect the market situation each month, they are deemed to include the matters covered by Options A and B, and so only one of the clauses has to apply. The purpose of this method is to reduce the amount of calculation that has to be undertaken by the project team.
These different types of fluctuations are referred to as limited fluctuations (Option A) and full fluctuations (Options B and C). In addition, it is of course possible to have no fluctuations provisions at all, by amending the contract. Such a procedure would however only be suitable for a small project under stable conditions.
ICC 11 approaches the question of fluctuations in a similar way to JCT. Again the fluctuations clauses are optional, but they are printed separately from the remainder of the contract and are based on published indices. However, to bring them into force requires a special condition added to the contract, rather than an entry in the appendix (equivalent to JCT’s contract particulars).
NEC3 ECC provides for price adjustments for inflation under its optional clause Option X1. The calculated amount is based on whatever index the parties have identified in the Contract Data. On the face of it, therefore, no adjustment is made for changes in taxes or the like. However, the form also includes at Option X2 a ‘change of law’ provision. Under this, a change which occurs after the contract start date is a compensation event. In this way, any adjustment arising from a tax increase or decrease introduced from new legislation would give rise to an adjustment to the contract price.
The FIDIC 1999 Red Book, like the NEC3 forms, does not use the term ‘fluctuations’ and provides for adjustments in two parts within the core clauses. Clause 13.7 provides for adjustments to the contact price arising from changes to legislation. This presumably also applies to changes to taxation. Indeed, the contractor is also entitled to an extension of time if such a change causes delay. Clause 13.8, for adjustments for changes in cost, only applies if so notified in the appendix to tender. Adjustments are calculated according to the details and appendices set out in that appendix. Provision is also made for the weightings in cost adjustment formulae to be adjusted if they have been rendered unreasonable, unbalanced or inapplicable as a result of variations.
15.5RETENTION MONEY
It is common practice in the construction industry to withhold a small proportion of payments to a contractor until the work has been completed satisfactorily. These amounts are referred to as retention and are usually deducted from each interim certificate.
15.5.1Nature and purpose of retention
The retention fund is intended to be available to the employer for the purposes of underpinning contractual performance, in particular rectifying, or inducing the contractor to rectify, any defects in the work appearing during the defects liability period (Hughes, Hillebrandt and Murdoch 1998). As we saw in Chapter 14, this
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period runs from the date of practical completion as certified by the contract administrator for whatever length of time is stated in the relevant project-specific data section (such as Appendix or Contract particulars). Six months is common.
Clauses 4.10.1 and 4.20 JCT SBC 11 illustrate the operation of a retention scheme. The first clause provides that, on the issue of every interim certificate, the employer is entitled to deduct the agreed retention percentage. This is deducted from the value of work that has not yet reached practical completion and from the value of any materials included in the certificate. Clause 4.20 specifies the rules as to its ascertainment.
It is stated that the retention percentage referred to will be whatever figure the parties have entered in the Contract Particulars. The default figure is 3% in SBC 11. Further, it is common to provide a ceiling beyond which no more will be retained, although JCT SBC 11 contains no such provision.
After the contract administrator certifies that practical completion has been achieved, but before the issue of a Certificate of Making Good, the deduction the employer is entitled to make is reduced by one-half. In effect, this means that the first interim certificate issued after practical completion will result in the release of one-half of the retention money currently held by the employer. The remainder will be released by the interim certificate required under clause 4.9.2, issued either at the end of the Rectification Period or upon the issue of the Certificate of Making Good, whichever is the later. The FIDIC 1999 Red Book treats retention in the same way as the JCT provisions, under clause 14.3 and 14.9, with deductions for retention within each interim payment, and release of retention in part at completion and later upon rectification of defects.
The treatment of retention in NEC3 ECC form is different in two respects. First, it is optional, covered in clause Option X16. It is not included as a core clause. Second, there is an opportunity for the employer to specify a retention-free portion of the overall price. This gives effect to an idea that the retention fund is not really needed until the end of the project.
15.5.2Retention bonds and guarantees
An alternative view, held particularly by contractors and sub-contractors, is that retention should be avoided as it is counterproductive, amounting to distrust over the quality of work carried out pending completion and rectification of defects. Further, sub-contractors do not receive retention amounts typically until settlement of main contractor accounts with the result that they are held out of sums for months, if not years, after completion of their works. Hence it is argued that monies held back as retention restrict cashflow and might be put to more productive use if available to sub-contractors. In order to provide some security to employers, the use of a retention bond or retention guarantee may be considered.
The JCT SBC 11 includes a model form of retention bond at Schedule 6. Within the contract particulars the employer must state whether such a bond is required, the maximum sum the bond is to protect and its expiry date. Clause 4.19 explains that if provided, this would replace the retention provision entirely so that no retention would be held. If no bond is provided retention may be held instead.
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The different arrangements are anticipated under the FIDIC 1999 Red Book. Here, after retention has been held for a period during the project and reached 60% of the maximum that might be held, there is an optional provision for 50% to be released and further retention amounts to be provided in the form of a bond or guarantee rather than having further sums withheld. To assist, FIDIC provides a model clause and model form of retention guarantee at Appendix F of the guidance section.
15.5.3Status and treatment of the retention
Clause 4.18 of JCT SBC 11 contains rules regarding the treatment of the retention money. Contractors and sub-contractors are naturally anxious to ensure as far as possible that, if the employer becomes insolvent, their claim to retention money will take priority over the employer’s general creditors. Clause 4.18.1 accordingly provides that the employer’s interest in the retention is fiduciary as trustee for the contractor (but without obligation to invest). The idea is to make the retention money a trust fund, though without imposing upon the employer all the investment and accounting duties of a trustee. If this is successfully achieved, a liquidator of the employer would be obliged to hand over the retention fund in full to the contractor.
It should, however, be noted that the words used in clause 4.18.1 are not in themselves sufficient to enable a priority claim to be made. This can only be done if the money in question has been set aside as a separate trust fund, usually in a separately identified bank account. Accordingly, JCT SBC 11 provides (in clause 4.18.3) that a contractor can require this to be done, albeit leaving the employer to keep whatever interest is earned. Interestingly, it appears that a contractor would be entitled to take such action even without a specific provision in the contract, on the basis that, if the retention money is a trust fund, it must be properly dealt with by the employer as trustee. This was laid down in Rayack v Lampeter Meat Co,9 an unusual case in which the retention level was 50% and the Defects Liability Period lasted for five years.
The Rayack decision, upholding the contractor’s rights, was followed in a later case where the predecessor to clause 4.18.3 (clause 30.5.4 of JCT 80) had been specifically deleted from the printed form of contract before it was executed by the parties.10 It follows that an employer under JCT SBC 05 who does not want to deal in this way with retention money (usually because the employer intends to use that money as working capital), will have to delete clause 4.18.1 as well as clause 4.18.3.
The right of a contractor to secure retention money in the way described above is subject to two important qualifications. First, an injunction will not be granted once insolvency proceedings against the employer have already commenced.11 This principle, which is based on the idea that the rights of all the creditors crystallize at that moment, was applied even where the bank which appointed
9 Rayack Construction Ltd v Lampeter Meat Co Ltd (1979) 12 BLR 30.
10Wates Construction (London) Ltd v Franthom Property Ltd (1991) 53 BLR 23.
11Re Jartay Developments Ltd (1982) 22 BLR 134.
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receivers under a floating charge over the employer’s assets had been given notice of the building contract terms at the time when the floating charge was granted.12
The second qualification is that a court will not grant an injunction against an employer who is making a bona fide claim against retention money (and the employer’s right to set-off claims against the retention money is specifically preserved by JCT SBC 11 clause 4.13.3). Thus, for example, where the contract administrator has issued a certificate of delay and thus entitled the employer to liquidated damages in excess of the retention, the employer will not be compelled to pay such money into a separate account. This will be so, even if the contractor is seeking to challenge the certificate.13 However, an employer can only adopt this course of action where the right of set-off is clear, for example where it is backed by a certificate. Where the employer’s claims, although arguable, are speculative and unsubstantiated, an order to pay the money into a separate account will be made.14
12MacJordan Construction Ltd v Brookmount Erostin Ltd (1991) 56 BLR 1.
13Henry Boot Building Ltd v Croydon Hotel & Leisure Co Ltd (1985) 36 BLR 41; GPT Realizations Ltd v Panatown Ltd (1992) 61 BLR 88.
14Concorde Construction Co Ltd v Colgan Co Ltd (1984) 29 BLR 120; Finnegan (JF) Ltd v Community Housing Association Ltd (1993) 65 BLR 103.
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