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The Equal Allocation of Risks in Public Contracts Report

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Updated: Jul 17th, 2020

Introduction

Governments and public institutions all over the world have used public-private cooperation to develop public projects. A public-private partnership model has brought numerous benefits in the design, implementation and completion of public projects.1 Projects under a public-private partnership can benefit from the facilitative capacity of public institutions as well as from their efficiency capacity.2 One of the most critical issues challenging the cooperation between the public sector and public institutions in developing public projects is the sharing of future risks. Because of their huge size and high public expectations, public projects will frequently face multiple bottlenecks which may become the future risks in the result. In the direction of trying to solve disputes between private and public institutions, FIDIC has been developing documentation that would be helpful for guiding the sharing of risks between public institutions and private firms.3

Background Information

In 1914, the International Federation of Consulting Engineers and the International Federation of Housing and Public opened their first offices in Switzerland. These two federations then published the first edition of the FIDIC contracts in 1957. The members of the FIDIC association include professional consulting organizations from 25 European nations. FIDIC has gained an international outlook after engineering consulting associations from America and Asia joined the umbrella.4 Because of a range of professional standards present in the FIDIC contracts, the World Bank has now proposed to only fund the international projects that adhere to the standards of the FIDIC contracts. After publishing the first suite of contracts in 1957, FIDIC has published several amended editions. Experience has contributed to the amendment of the proceeding FIDIC editions.5 Most of the current international projects in developed countries (such as European nations) follow the 1999 FIDIC edition suite. The 1999 FIDIC suite distributes more risks to the developer than the previous editions did.6 On the other hand, developing nations find the 1987 FIDIC edition more suitable than the previous ones due to their environment development.7 Such a direction could arise due to the high level of political risk that was present in many developing nations; hence, a need to share risks more equally between the employer and the developer has appeared.

The 1999 FIDIC edition has four model scenarios for sharing risks between the employer and the contractor. The condition for contract book (red book) has laid out procedures for procurement as well as the construction of guideline contract. Here, the developer is responsible for preparing the project work, while the contractor should execute the project according to guidelines. The condition of contract for the design of plants (also called yellow book) is for guiding installation of engineering projects. The silver book is useful for guiding factory and power plant projects. The green book is applicable to different forms of small engineering projects that do not necessarily require the supervisory services of a consulting engineer.8 Project that can be referred to a green book contract is a short term project that requires completion within six months. The FIDIC red book has two main parts. The main section of the red book contains a list of general principles that should be included in project contracts. The special principles’ section of the red book contains a list of procedures for guiding the creation of guidelines that are unique to the project environment. Special principles must align with the provisions of the general principles.9

The European Institute of Contractors recommends that standard contracts, such as the FIDIC ones that distribute risks equally in key areas, would be used in projects that require the funding of international banks. The most important areas that need a balanced system of risk allocation between the employer and the contractor include obstructions, design, payment methods, certification and procurement. The silver book volume of the 1999 FIDIC contracts deviates slightly from the previous editions of the FIDIC suites by unequally distributing risks between the employer and the contractor.10 As such, the silver book of the 1999 FIDIC edition is useful in designing international contracts. In view of the above limitations, the EIC has embarked on an effort of publishing the provisions and shortcomings of standard contracts, such as the FIDIC ones.11

Due to inevitable circumstances, which could lead to future disputes between the employer and contractor, standard contracts (such as the FIDIC) have a mechanism that can be applied for dispute resolution purposes. Here, dispute boards and international arbitrator associations should be used to address arising disputes between the contractor and the employer. The need for international arbitration should not be limited to the agreement of a controlling body in a given country. The main bottleneck against the use of international arbitration mechanisms in resolving contract disputes is that many international engineering firms have not ratified the 1958 New York Convention on arbitration.12 From most of those that have ratified the New York convention, they do not recognize its provisions.13 Therefore, the capacity of International arbitration mechanisms to solve contract disputes remains limited.

The main challenges that have contributed to disputes between the employer and the contractor in contract agreements resulted from the possibility of varying the specific conditions in the FIDIC contracts to make amendments that would alter the general provisions. As such, FIDIC has emphasized the need to use the specific conditions on matters that relate to the regulation of a project in accordance with unique provisions that are present in a given country.14 Specific conditions should only relate to matters specific in a given country, such as the social and the economic environments and geological peculiarities.15 Specific conditions are not designed for creating loopholes that would allow the re-allocation of risks apart from what is provided for in the general conditions. The EIC has warned international banks against funding projects that have such loopholes as those mentioned above. Moreover, the EIC has prohibited a contracting body from disqualifying a tender bid founded on the assumption that risk deviations are disallowed. Generally, the EIC requires contracts to be completed according to the FIDIC standards. Besides, contracts must be fair to both the parties; hence, they need not to allocate risks to the contractors that arise from such parameters like liquidation risks.

While commenting on the first edition (1957) of the FIDIC contracts, Julius Triton, the founding president of FIDIC, noted that the purpose of the organisation was to create a framework for equally allocating risks between the employer and the contractor. Thus, the FIDIC contracts are designed to protect the employer as well as the contractor. Succeeding editions of the FIDIC contracts follow an approach of detailing general and specific conditions for regulating projects. Fundamental provisions on the procedure of regulating a project by the employer are provided for in the general conditions section. The special conditions allow for modifications that can fit a project in the context of unique environments where a given project runs. As observed, specific conditions can only be altered in accordance with the general provisions and should not deviate from the initial distribution of risks in the general conditions.16 A number of clauses in the FIDIC suite can be altered, while given clauses are to be constructed in accordance with the project work. There is even a provision for amending some sections of the general provisions although such an amendment is not about the risks re-distribution apart from what was initially agreed upon by employer, consulting engineer and developer.17

The purpose of the FIDIC contracts is to guide and advice the relationship of the employer and the contractor during the project work. The FIDIC contracts do not establish any legal liability on any of the participating parties in a project; thus, the employer should draw a legal contract that that will legally bind the parties. While drawing up a legal contract, it is common for participating parties to make a number of amendments and new provisions. As such, if the contract is based on the agreement between individual representing a legal entity and contractor, a public institution for which a specific individual approves all the changes in the original agreement. The FIDIC contracts contain clauses that allow for the alteration of works by the consulting engineer. Here, the contractor is obliged to meet new requirements in the project works as the engineer may recommend.

Generally, the FIDIC suite of contracts is useful in creating a framework that balances the allocation of risks between the employer and the contractor. The FIDIC suite of contracts assigns clear responsibilities and obligations to the contractor and the employer. Failure to play on the part of any party to meet the set demands will result in the shifting a risk balance between the contractor and the employer. Due to their large scale nature and high public expectation, many public projects frequently result in disputes. Failure to reach an agreement through arbitration mechanism will often result in a legal litigation. The understanding of laws’ implementation regulating how risk allocation aligns with delay, disruption and quality is essential in solving legal disputes that originate from public projects.18

In a case between the government of the United States and Schnip building, the contractor had encountered a set of different conditions specified in the contract.19 After incurring additional costs, the contractor sued for an increment in the price of the contract. The claim for an increase in price of the contract was dismissed on the ground that the contractor had not given a written 20-day notice to the government of the USA detailing the encounter of the conditions different from those that had been specified in the contract. A 20-day notice is among the main requirements needed for complaint award. Fru-con Corporation was also denied a claim for an increase in contract costs due to failure on its part to inform the United States government about changes in weather.20

The use of float time and critical paths is among the methodologies used to evaluate project disruptions and delays. Float time is the amount of time in which a project can exceed the earliest date of completion without delay in the overall schedule of project completion. However, according to the understanding of many governments, float time is only for the purposes of the government/employer’s benefits. On the other hand, a critical path is a set of related activities in a long list of sequence to complete a project. Delays and disruptions are often argued based on the definitions of float time and critical paths. Here, it is important to note that since it affects the sequence path of a project, a disruption can directly affect float time. In case of Santa Corporation, the US government was not obliged to pay for damages despite a float provision since the claimant could not prove that the actions of the US government had led to the disruptions.21

Conclusion

The equal sharing of risks between public institutions and contractors is necessary for effective implementation of public projects. Aligning national projects with the international contracting standards, many governments and international forms base their contracts on the FIDIC contracts’ standards. The use of mechanisms that prevent an alteration risk balance is among the most useful approaches in preventing the exploitation of contracting parties facilitated by the FIDIC contracts. In the direction of trying to solve disputes between private and public institutions, FIDIC has been developing documentations to guide risks sharing between public and private organisations. Generally, the FIDIC contracts have laid a foundation that can help to design contracts that equally allocate risks between the parties involved.

Bibliography

Abednego, M. “Good project governance for proper risk allocation in public-private Partnerships in Indonesia” Manage, vol. 8, no. 2, 2007, pp. 622–634

Chen, C. “BOT application in China: Driving and Impeding factors” Manage, vol. 10, no. 2, 2008, pp. 388–398.

Lam, K. “Modelling risk allocation decision in construction contracts” Manage. Vol. 7, no. 5, May 2007, pp. 485–493.

National Council for Public-Private Partnerships, USA “How PPPs work Public private partnerships defined” Aug 2009, The Economy, pp. 15-39

Sachs, T., 2007 “Analysis of political risks and opportunities in public private Partnerships PPP in China and selected Asian Countries: Survey results.” China Management Studies, vol. 25, no. 4, 2007, pp. 126–148.

Footnotes

1 Abednego, M. “Good project governance for proper risk allocation in public-private partnerships in Indonesia” Manage, June 2007, pp. 622–634.

2 National Council for Public-Private Partnerships, USA “How PPPs work Public-private partnerships defined” Aug 2009, pp. 15-39.

3 Abednego, p. 628

4 Sachs, T., 2007 “Analysis of political risks and opportunities in public-private partnerships PPP in China and selected Asian Countries: Survey results.”

China Management Studies, Aug 2007, pp. 126–148.

5 Abednego, p. 629

6 Chen, C. “BOT application in China: Driving and Impeding factors” Manage, Dec 2008, p. 388.

7 National Council for Public-Private Partnerships, USA, p. 20

8Chen, p. 485

9 Lam, p. 490

10 Lam, K. “Modelling risk allocation decision in construction contracts” Manage. 25.5, May, 2007, pp. 485–493.

11 Abednego, p. 628

12 Abednego, p. 628

13 Abednego, p. 628

14Chen, p. 485

15 National Council for Public-Private Partnerships, USA, p. 11.

16 Abednego, p. 640

17 Sachs, p. 129.

18 Lam, p. 490

19 Lam, p. 490

20Chen, p. 485

21 Lam, p. 490

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IvyPanda. "The Equal Allocation of Risks in Public Contracts." July 17, 2020. https://ivypanda.com/essays/the-equal-allocation-of-risks-in-public-contracts/.

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IvyPanda. 2020. "The Equal Allocation of Risks in Public Contracts." July 17, 2020. https://ivypanda.com/essays/the-equal-allocation-of-risks-in-public-contracts/.

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