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With the construction market still under cost pressure, principals have been resorting more to negative variations to de-scope projects and reduce overall capital expenditure.
Use of this instrument can, however, be contentious - particularly where a large portion of work is removed and even more so when the omitted work is awarded to another contractor, typically for a lower price.
Contractors argue that such omissions undermine the original agreement and cause economic detriment. So it is important to know how these variations operate and the limitations or risks that might apply.
Legal principles
Case law has established the following principles regarding negative variations:
- explicit contractual right - negative variations cannot be instructed unless the contract explicitly allows it
- purpose of instruction - negative variations must be instructed for the purpose for which the right was given. This includes the right to omit work in order to engage another contractor or to permit the principal to carry out the omitted works itself, and
- economic detriment - the negative variation cannot undermine the original bargin or lead to the contractor’s economic disadvantage.
Standard form contracts
Four contract form options are available.
NZS391X
- Allows the principal to omit work (9.1.1(b)).
- Does not allow the principal to undertake or reassign the omitted works.
- When valuing a negative variation, the deduction does not include any allowance for margin (meaning that the contractor will still be paid its margin for the omitted works), mitigating economic detriment.
FIDIC
- 1999 editions: allows the employer to omit work (13.1(d)) but expressly states that variations cannot omit work to be carried out by others.
- 2017 editions: same provisions, but allows for agreement that omitted work can be undertaken by others, in which case the contractor may claim for loss of profit and damages suffered.
NEC3 and NEC4
- Allows the project manager to issue instructions changing the scope, including omissions.
- Reductions in total defined cost do not include margin, allowing the contractor to retain its margin.
JCT Design and Build 2016
- Allows the employer to omit work (5.1.1.1).
- Does not allow the employer to reassign the omitted works.
- The omitted works are to be valued by agreement or by the quantity surveyor, with no indication on margin inclusion.
Practice considerations, limitation and risks
Negative variations are intended as a tool to address technical or commercial doubt in the scope of works. The standard forms generally allow for omissions but not for the principal to undertake the omitted works or reassign them. Without clear contractual terms, such actions would be objectionable.
The standard forms also generally allow for the contractor to retain its margin on the omitted work. Principals will often seek to negotiate this.
There are limitations and risks in using negative variations.
- Substantial omissions - regardless of whether a contract allows negative variations, drafting needs to be clear as to the potential extent of substantial omissions. Substantial omissions are often described as ‘termination by stealth’ and may constitute a breach of contract or repudiation. The Court will consider whether the omission undermines the original bargin struck between the parties.
- Contractor’s remedy - where a principal is found to be in breach, the contractor’s remedy is usually the award of its lost profit on the omitted works and any direct costs incurred in anticipation of undertaking those works.
Take-outs
Negative variations must be carefully managed to ensure compliance with contractual terms, and should be considered and clearly agreed at the outset of the contract to mitigate risks and disputes later on.
Anyone thinking of issuing a negative variation should take care to review their existing contract and the underlying common law position, to ensure they are not risking a breach of contract or repudiation claim.