This article is part 3 of a series of articles comparing the SIA form against the PSSCOC form. As with the preceding parts of this series, the basis of comparison is the main contract standard conditions of SIA form published in 2016 and the PSSCOC published in 2020. In general, the SIA form and PSSCOC takes a fairly different approach in its respective valuation of variations mechanisms where the former is more detail, structured and defined. However, valuation of variations is a unique area of construction law where its day to day application is more of a ‘technical matter’ than a ‘legal matter’. Therefore, the more granular a contract condition is drafted, the more challenging it could be for a non legal construction practitioner to understand and apply such provision as intended. 

Valuation of variation is an important subject because variation is most certainly part and parcel of administration of construction contract. It is famously said that nothing in this world can be certain except death and taxes. Likewise nothing in construction project can be more certain than variations. Without clarity in the way such variations are to be valued and paid, it could easily become a major point of contention and sources of disputes. A comparison of the different approaches in these two forms of contract allow one to have a more comprehensive qualitative understanding on how variations are supposed to be valued. Therefore comparison is a key plank to acquiring an in-depth grasp of a subject.

Variations under construction contract generally refers to changes to the scope of works that likely attracts financial implications which alters the contract sum. Various forms of contract typically provide its own definition of variations and are usually defined broadly including any change in character, quality or nature of any part of the construction works. In other words, the original scope of construction works agreed at the commencement of the project could be significantly different from what is finally built. Whilst the contractor could provide its tender price of the original scope of works based on the drawings and specifications issued, how should its price be amended in tandem with those changes introduced subsequently? The answer is in the mechanism of valuation of variations. Regardless of the types of contract form used for construction project, there are some general rules applicable to valuation of variations which will be elaborated in the next section of this article.

General Rule of Valuation of Variations

Variations are valued typically based on a tiered approach under most standard forms of construction contract. There are in general four tiers to this valuation structure. Under tier 1, the contractor is bound by its existing unit rates and prices included in the contract document. The extreme end of the spectrum is tier 4 where the contractor will be compensated based on its costs plus any agreed percentage that covers the overhead, profit, supervision etc. Purely from the contractor’s perspective, tier 4 is the most favourable method of valuation since it will be reimbursed for its actual costs incurred in addition to an agreed percentage allowance for profit. There is no commercial risk for the contractor in this regard. On the other hand the least preferred approach for the contractor should be tier 1. This is because the contractor is likely to have submitted competitive prices and unit rates during tender to secure the project. If the variation is valued based on contract rates and prices under tier 1, it is not guaranteed that it will even be able to recover its cost for carrying out the variation works. Tier 2 refers to the use of contract rates and prices to value variations with some allowances for these rates to be extrapolated or adjusted. Tier 3 refers to fair market rate. Given the opposing commercial preferences between the contractor and the Employer as regards which tier to be used for valuation, the mechanism that stipulates the choice of tier to be used becomes critical.

The choice of tier to be used for valuation is generally dependent on the timing in which the variations are instructed. The more disruptive the variations works could be to the progress of works on site, the higher the tier will be used to compensate the effects of such variations. Apart from timing, choice of tier is also dependent on whether there are existing unit rates and prices under the contract for the instructed works. By way of example, if the variation works involve replacing existing floor finishes with a different material that is not originally provided for under the contract, there will be no contract rates available to value such new works. Therefore tier 1 and tier 2 will automatically not be applicable, leaving the remaining options of tier 3 and tier 4.

Whilst most standard forms of contract adopts the principles set out above, there could be certain nuances and deviations based on different risk allocation philosophies. The next section of this article examines how the SIA and PSSCOC deal with its own valuation of variations mechanism.

How Do SIA and PSSCOC Deal With Valuation of Variations?

Clause 12(4) of the SIA form sets out its valuation mechanism. On the  other hand, PSSCOC has its main provision stipulated under Clause 20.1. Between these two forms, PSSCOC has valuation mechanism that more resembles the general rule set out above, with some modifications and additions. As pointed out earlier, the SIA form on the other hand has a more detail, structured and defined valuation mechanism that expanded considerably from the general rule.

Tier 1

Clause 20.1(a) of the PSSCOC resembles tier 1 where contract rates shall be used to determine the value of varied works if such works as compared to original scope of works is of a similar character, executed under similar conditions and are of moderate quantity. By contrast Clause 12(4)(a) of the SIA form resembles tier 1 where the unit rates and prices shall be applicable as means of valuation of variation. However in addition to valuing the actual variation works, the preliminaries expenditure may also be adjusted where necessary based on the make up of the contractor’s prices that are disclosed under Clause 5 of the SIA. The additional allowance under the SIA form for preliminaries costs in respect of variation claims is not widely practised as preliminaries are traditionally claimed under the heads of loss and expense. Proponents of the SIA approach will point out that by including preliminaries costs under valuation of variations, it allows the Employer and its consultant to appreciate the holistic cost of any variation works rather than just the direct cost of the actual works. Critics of the SIA approach however will argue that it is not advisable to unnecessarily blend variation cost with preliminaries cost/ loss and expense claim because these should be treated differently. Variation cost can be valued by simply measuring the quantities of the varied works and multiply it against unit rates. Loss and expense or preliminaries cost can be more complex and involves much more details for a proper assessment. This includes documentation proof of whether additional overhead resources are deployed as a direct result of the variation works concerned due to prolongation of operations on site, loss of productivity etc. These are not traditionally issues that will be implicated under simple and straightforward variation claims. If and when the valuation of a simple variation cost is magnified disproportionally, it may expand the time taken to complete the assessment and could affect payment and project cashflow. The complexity is compounded by the fact that there could be multiple variation works occurring on site simultaneously including breaches of contract by the Employer. It is not easy to establish a direct causation between each and every event with the relevant additional preliminaries costs. This is why the PSSCOC has a separate and distinct loss and expense clause from valuation of variation clause as with most other standard forms including the JCT form.

Tier 2

As regards tier 2, this can be found in Clause 20.1(b) of the PSSCOC. The SIA form on the other hand, deals with tier 2 under two separate provisions namely Clause 12(4)(b) and 12(4)(c). As mentioned in the preceding section of this article, tier 2 is in essence valuation using contract rate with some extrapolation or adjustments or fair allowances. This is when the contract rate itself is not entirely suitable due to various reasons. The term ‘adjustments’ or ‘extrapolations’ or ‘fair allowances’ are subjective. How contract rates are adjusted is often subject to debate. The extent to which contract rates could be adjusted is also grey. There is also an absence of adjustment/ extrapolation formula. By way of example, assume that the contract unit rate of 1m3 of ready mix concrete is $120/m3 and the parties are in agreement to use tier 2 mechanism to value a variation involving an additional 1% ready mix concrete from the total contract quantity. The contractor may claim additional cost based on $360/m3 because the quantity is small and requires additional trips of concrete mixer trucks working on overtime basis during peak period. The Employer’s consultant may disagree on the basis that three times the contract rate is no longer a mere fair allowance or extrapolation but a new rate entirely. It is not difficult to envisage how a variation of such nature with subjective valuation mechanism can be a source of dispute. The idea of having an agreed valuation mechanism should be to avoid or minimise dispute over how variations should be assessed. The situation is exacerbated by the fact that the SIA valuation mechanism under both Clauses 12(4)(b) and 12(4)(c) allow for additional claim for adjustments to preliminaries expenditure which in and of itself can be complex as well. This is because, various site plant and machineries for concreting works could be allocated under preliminaries cost allowing for duplicative claims under both preliminaries as well as unit rates. 

Whilst Clauses 12(4)(b) and 12(4)(c) of the SIA form appear to be part of tier 2 valuation mechanism due to certain shared similarities, there are some distinct differences between operations of these two clauses. In terms of similarity, both these clauses allow the use of contract rates and prices as the basis of valuation with allowances or extrapolation to be made to these rates and prices. In terms of differences, Clause 12(4)(c) is to be used only when the varied works shall not be readily absorbed into the contractor’s programme whereas Clause 12(4)(b) is used when there shall be no exact equivalent item described in the contract. One may reasonably struggle with such distinction. This is because where an instructed work is not readily absorbed into the prevailing programme, it also mean that the existing rates and prices is no longer of equivalence valuation wise. Another difference between these two clauses is the extent to which adjustments to existing rates and prices are allowed. As regards, Clause 12(4)(b) it merely refers to allowance for extrapolation whereas Clause 12(4)(c) allows adjustments made to prices due to (1) change in quantity (2) sequence of ordering (3) special physical and technical circumstances etc. However, it is interesting to note that Clause 12(4)(c) forbids rates adjustments due to change in the level of labour or material costs. In reality, to assume that one is able to make those distinctions clearly when making calculation of variation cost might require an exceptional high degree of optimism. By way of further example Clause 12(4)(c) emphasises that any valuation under this mechanism shall not take into account any change in “level of building cost”. However when extrapolation is made to existing unit rates and price, such extrapolation will invariably involve replacing elements of the existing prices with other elements of substitution that is considered more appropriate based on prevailing market condition. When prevailing prices are used in lieu of contract prices, it is challenging for one to ensure no change in level of building cost. Contract prices which are submitted during tender months ago before variations works are instructed are likely to be different from prevailing prices. Taking into considerations the characteristics of Clause 12(4)(b) and 12(4)(c) of the SIA form, it would appear that its counterpart under PSSCOC of Clause 20.1(b) seem a lot more straightforward and easier to apply.

Tier 3

As regards tier 3, this can be found in Clause 20.1(c) of the PSSCOC as well as Clause 12(4)(d) of the SIA form. Tier 3 is used when tier 1 and tier 2 are not applicable, presumably when the varied works involves new materials or finishes that are not provided for under the contract. This therefore requires the named consultant Quantity Surveyor and/or the certifier appointed under the contract to apply ‘fair market valuation’. 

It should be no surprise that the concept of fair market valuation can be both subjective and elusive. The outcome of the application such principle may vary depending on different point of views. From the Employer’s point of view, it is only fair if the valuation takes into consideration the price competitiveness of the contract rate in general when valuing such variation. From the contractor’s perspective, it is only fair if the valuation is based on prevailing market rates regardless of the price commitment made at the point of tender since the contractor could not have contemplated the variation works in advance. Some may also argue that the concept of fairness should duly take into consideration of the general level of profitability of the contractor with respect to its pricing under the contract. After all, the contractor should not be financially worse off for changes to works that are initiated by the Employer. In fact, the reliance on element of profitability is supported by the SIA form’s tier 3 where the valuation shall be based upon the contractor’s overall level of contract prices and profitability. Upon determining the profitability, the Quantity Surveyor shall not make any adjustments to such level of profitability. In other words, if the Quantity Surveyor is of the view that the contractor’s level of profit is allegedly 5%, this should remain fixed in his valuation under tier 3. This approach is however very unique and apparently not adopted under the PSSCOC. The PSSCOC’s tier 3 is rather brief and succinct where it merely states that ‘measurement and valuation at fair market rates and prices’. This brevity can be an advantage because it allows the valuation to be carried out without any unnecessary shackle.

Tier 4

As pointed out in the earlier section of this article, tier 4 is generally an approach where the contractor shall be paid for variation works based on the the cost it had incurred, including a certain percentage, usually 15% to account for profit and overhead. This is considered the most favourable approach for the contractor since it is guaranteed that the contractor will not be carrying out the variation works at a financial loss. 

It should be noted that tier 4 typically consists of two valuation routes namely tier 4.1 which is the day work rates method and tier 4.2 which is the actual cost plus 15% method. Whilst both these routes guarantee that the contractor will not incur any financial loss for the variation works, the documentation requirements are slightly different. Both the SIA form and PSSCOC adopt tier 4.1 and tier 4.2 but they are sequenced differently in the respective forms of contract. 

Under the SIA form, its tier 4.1 can be found in Clauses 12(4)(e)(ii) and 12(4)(e)(iii) whereas its tier 4.2 is in Clause 12(4)(e)(iv). Tier 4.1 requires the use of day work rates found in the pricing section of the construction contract where a list of hourly rates or daily rates for various construction resources such as plant, equipment, machineries, labour etc will be listed. The contractor will be required to document and record the number of hours or days that each resource are in use for the purposes of the variation works. Such records are then verified by the Architect or any of the authorised representatives by the end of the following week after the works are executed. Under tier 4.2, the valuation shall be based upon actual prime cost incurred by the contractor plus 15% allowance for profit and overhead. By default tier 4.1 will first be adopted under the SIA form. Tier 4.2 will only be adopted if tier 4.1 is not available where the day work rates are not found in the contract document. Tier 4.1 is the default option since the contractor is still bound by the day work rates that it had provided at the point of tender. There is no incentive for the contractor to carry out the works in the most productive manner since it will ultimately be paid based on actual duration it had expended provided that these are recorded and verified.

The PSSCOC’s tier 4.1 can be found in Clause 20.4 whereas its tier 4.2 can be found in Clause 20.1(d). The PSSCOC’s approach is completely the opposite to the SIA form as regards the sequence of these two routes. If tier 1, tier 2 and tier 3 are not applicable, then by default tier 4.2 will be adopted. The contractor will therefore be reimbursed based on its actual cost incurred including an additional 15% to account for profit and overheads. Tier 4.1 will only be used if the Superintending Office (SO) elects to do so. Just as the approach under the SIA form, those day work rates shall be applied based on recorded durations which had to be verified after the work is executed. Purely from a commercial point of view, tier 4.2 appear less administratively onerous and favourable to the contractor than tier 4.1. Therefore, it is curious why would an SO decide to adopt tier 4.1 in lieu of the default option of tier 4.2. The PSSCOC states that the SO is only required to opine that the adoption of tier 4.1 is deemed ‘necessary and desirable’. In reality however, it is likely that whether tier 4.1 or tier 4.2 is adopted, the outcome of valuation may be close or very similar. This is because, the day work rates submitted by the contractor are likely to be in line with market rates since these day work rates do not directly affect the competitiveness of the tender price. From the contractor’s perspective, the only element of pricing that are subject to competition are the composite unit rates of the actual scope of works included in the contract sum.

Lastly, there is a unique Clause 20.5 of the PSSCOC that is not found in most standard forms of contract including the SIA form. This clause belongs to neither of the four tiers. According to this Clause 20.5, the SO is authorised to adjust any of the contract rates if it is found to be excessive or inadequate. These rates can be replaced with other rates that are deemed fairer in line with the market rate. Since the power of the SO is only provided for under the contract, this clause is applicable after the construction contract is formed. It is curious as to why these ‘problematic rates’ are not negotiated prior to formation of contract. This clause appears to be a circuit breaker to the application of the four tiers of valuation since the SO is able to dictate an alternative rate that is deemed ‘fairer’. If this clause is invoked, it would appear that all four tiers are mere academic valuation options as one can bypass these options. It would be interesting to find out how often is this clause is actually used and whether it can withstand the scrutiny of a legal proceeding.


Conclusion

It is quite clear from the above that valuation mechanism of any variation works can be complex and differ according to the types of contract form being used. However, most construction practitioners usually adopt the same valuation calculation methodology regardless of the types of contract form being used. It is rare to see projects administer its valuation of variations differently according to the actual rules stipulated under the contract. This conventional practice ought to be reviewed especially if the project is prone to disputes which could culminate into legal proceedings. On the other hand, if one takes the position that valuation of variations rule ought to be clear and straightforward, the relevant clauses should be negotiated.





Koon Tak Hong Consulting Private Limited