ADR Digest 1

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Digest
Winter 2007 Issue 2
Contractors Beware:
the new Handbook
and prolongation
costs

By James B Longbottom BSc(Hons) LLB(Hons) FRICS
FHKIS FCIArb RPS - Managing Director, ADR Partnership Ltd
Introduction
In December 2006, the Government of the Hong Kong
Special Administrative Region introduced its controversial
Handbook for Preparing Bills of Quantities for Civil
Engineering Works (the Handbook) which is to replace
the Standard Method of Measurement for Civil Engineering
Works, 1992 Edition (the SMM). ADR understands that the
Handbook will be issued on a trial basis on 10 new tenders
although there have been comments from within the
industry that the trial projects chosen by Government
appear to be either small or term contracts and, therefore,
are inappropriate for any meaningful evaluation.


The Handbook
This article is the frst of two articles analysing some
of the changes in the method of measurement in the
Handbook from those in the SMM, and concentrates on
one aspect of the new Handbook which is the paying for
prolongation costs through pre-priced measured items
in the Bills of Quantities (BQ) and the effects that the
provisions have on overhead recovery from variations.


Prolongation Costs
In the Handbook, the measurement of extended time
based preliminaries during a period of Contract overrun
is based on the following principles:
Preliminaries other than the Contractors overheads
(eg. temporary accommodation for the Engineer and
In this issue:
1 Welcome
1 Contractors Beware: the new Handbook and
prolongation costs
5 Compromise: Recovering the settlement that
shouldnt have been
Welcome
In this edition of the ADR Digest, James Longbottom takes
a look at the Hong Kong Governments new Handbook
which replaces the Standard Method of Measurement for
Civil Engineering Works. James considers one aspect of the
new Handbook which is the paying for prolongation costs
through pre-priced measured items in the Bills of
Quantities and concludes that the changes are bad news
for contractors and for the industry in general.
Our guest writer in this edition of the ADR Digest is Timothy
Hill, Partner of the law frm Lovells. Tim considers a recent
English court decision on compromise settlements and
offers some practical advice for parties faced with a problem
of whether to settle a disputed claim and then look to
recover the settlement at a later date from third parties.
In this edition, we also commence the ADR Analysis series
which will address key commercial and contractual
principles arising on construction projects. The frst in the
series considers what happens if there is delay caused to a
project by inclement weather within an extended period
after the original date for completion.
As part of our continued growth within the region we
extend a warm welcome to three new members into our
team - Derek Dixon, Travis Ling and Kaymond Lam -
see our news section for further details.
Finally, we would like to wish you all Seasons Greetings
and a very prosperous New Year.

Patrick J ONeill
Director
7 ADR Analysis: Inclement Weather
8 ADR News
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photographs) are measured during an extended time for
completion; and
Contractors overheads (eg. personnel, plant, temporary
accommodation, site and off-site overheads) are measured
during an extended time for completion which is due to
causes relating to the direct actions of the Employer /
Engineer (these are defned in Figure 1 and referred to in
this article as compensable extensions of time).

In the Preface to the Handbook, Government argues that
these provisions:
... do away with the time consuming and resource
demanding Cost ascertainment exercise associated with
excusable delay by measuring and paying such Cost
through items in the Bills of Quantities.
However, a closer look at the provisions reveals that they raise
serious problems with respect to a Contractors entitlement
to the recovery of Contractors overheads arising from
variations and prolongation.


Variations
Typically, Contractors overheads are priced in both the
Preliminaries and the items for measured works in the BQ.
However, paragraph 1.2 of the Preamble to the Handbook
deems that the Contractors overheads, including the
overheads of his subcontractors of any tier, shall be included
exclusively in the rates for Contractors overheads and not
against other items of work in the BQ.
This means that if the Contractor follows the Handbook the
valuation of variations based on existing BQ rates for items of
measured work will no longer include for the recovery of
Contractors overheads. Moreover, Special Condition of
Contract (SCC) Clause E(3) which accompanies the Handbook
provides that:
...the provisions in General Conditions of Contract Clauses
59(4)(b) and 61... shall have no application to the rates
inserted by the Contractor against the items of work under
the sub-heading Contractors overheads in the Bills of
Quantities.
Therefore, any adjustment for increased quantities rendering
BQ rates unreasonable or inapplicable (GCC Clause 59(4)(b)) or
the valuing of new rates (GCC Clause 61) will also exclude
Contractors overheads. The upshot being that:
any additional or thickening of Contractors overheads
arising from variations which materially affect the progress
of the Works (eg. additional supervisory staff and head
offce support) will have to be recovered as Cost pursuant to
GCC Clause 63(b) ie. a reversion back to the time consuming
and resource demanding Cost ascertainment exercise!;

where any additional or thickening of Contractors
overheads arises from variations which do not materially
affect the progress of the Works, the Contractor will not
have any contractual grounds for recovery and will lose
money; and
Contractors will also lose money on variations which
include price related Contractors overheads (eg. levies).


Pricing Contractors Overheads
The guidance notes in Part III of the Handbook state that the
number of months inserted for Contractors overheads in the
Quantity column of the BQ should include for:
the original time for completion of the Works;
a reasonable allowance for compensable extensions of time
that may be granted; and
the Maintenance Period.
In other words, monthly rates priced for Contractors
overheads should be calculated as a composite average based
on the above estimated costs divided by the number of
months inserted in the Quantity column of the BQ.
The frst point to pick-up on is the inclusion of the
Maintenance Period in the overall duration for Contractors
overheads. This has the effect of artifcially reducing the
average BQ rate priced by the Contractor (see Figure 2).
This in turn distorts and backloads the recovery of overhead
expenditure placing the Contractor in negative cash position
which the Contractor has to fnance until the end of the
Maintenance Period. This is nonsensical and ADR understands
Figure 2: Example of Monthly Overhead Expenditure
GCC
Clause
Causes of Delay Causes Relating
to Direct Actions
of the Employer /
Engineer
50(b)(i) Inclement Weather No
50(b)(ii) Tropical Cyclone No
50(b)(iia) Black Rainstorm No
50(b)(iii) Ambiguity or Discrepancy Yes
50(b)(iv) Variation Yes
50(b)(v) Substantial Increase in Quantities No
50(b)(vi) Late Possession Yes
50(b)(vii) Disturbance Yes
50(b)(viii) Suspension Order Yes
50(b)(ix) Utility Company No
50(b)(x) Nominated SubContractor No
50(b)(xi) Special Circumstances No
Figure 1: Causes of Delay Relating to the Direct Actions of the
Employer / the Engineer
2 Winter 2007
that Government has undertaken to amend this and that the
latest draft of the Handbook actually does so. It is worth
mentioning this point, however, since the published version
available in the public domain refects the above wording.
More importantly, it shows the extent to which the new
provisions have not suffciently been thought through.

Competitively Priced Delays
The next point to pick-up on is the allowance for compensable
extensions of time. Putting aside the fact that it is bizarre that
a project should include an estimate for overrunning before it
has even got started, this provision means an increased
amount included for the allowance for compensable extensions
of time will increase the tender price. Put another way, if a
tenderer prices the allowance low, his overall tender price will
therefore be lower is this what Government wants,
competitively priced delays?
SCC Clauses E(1) to (3) which accompany the Handbook re-
defne the meaning of Cost to exclude prolongation costs and
provide that the measurement of Contractors overheads
whether or not resulting in payment, shall exonerate the
Employer from any further liability in respect of overheads,
whether on or off Site including head offce overheads, cost of
fnancing and depreciation in the value of Construction Plant,
of the Contractor and any of his subcontractors of any tier
under the Contract. Therefore, the Contractor is stuck with
his pre-priced rates for valuing prolongation and there is no
mechanism for recovering any shortfalls as Cost under
GCC Clause 63.
In situations where the Contractor under estimates or simply
prices his Contractors overheads competitively so that they no
longer refect his actual costs, the Employer will gain a fnancial
beneft for any prolongation. This contradicts the established
principle of putting the Contractor back in the position it
would have been but for the compensable delay.
Moreover, can an average cost ever fairly and realistically
refect the fnancial effects of a delay throughout the
construction period of a major civil engineering project?
It is a recognised principle that prolongation costs should be
ascertained during the period that the delaying effects are
felt. This is an important concept as usually a Contractors
overheads will gradually increase, peak and then decrease
during the construction period. Therefore, the fnancial effects
of a delaying event are likely to be greater mid-way through
construction than towards the end of project when resources
are starting to wind down. This is why in Figure 2 the
allowance for compensable extensions of time was priced at
the peak of the curve; ie. a belts and braces approach was
taken to cover the worst eventuality. However, if the
Contractor priced the allowance at a lower point on the
expenditure profle to keep his tender price competitive, this
would result in the under recovery of prolongation costs felt
at the peak of the curve.























The Risk of Time Overruns
If the compensable extensions of time for the project
described in Figure 2 transpired and the rates for Contractors
overheads realistically represented the Contractors actual
costs, then all should be well.
However, if the project fnished later than the period measured
in the BQ for compensable extensions of time, then the
Contractor would make a fnancial loss (the converse would occur
if the project fnished earlier than the period measured in the
BQ; ie. the Contractor would in theory make a fnancial gain).
For example, in Figure 2, the period measured in the BQ for
compensable extensions of time was 3 months. However, if
the compensable delay was actually 4 months, the actual cost
of the additional month of prolongation (assuming the effects
were felt at the peak of the expenditure curve) would be HK$4
million. If this prolongation was measured using the BQ rates
(excluding the Maintenance Period), the Contractor would
recover only an additional HK$3.2 million, a shortfall of
HK$0.8 million.
Further, extensions of time in Hong Kong are often granted
retrospectively after the Contract has fnished so the
measuring and valuing of the prolongation costs using
pre-priced measured items in the BQ is likely to make little
difference in reality, in the Contractor receiving reimbursement
of the additional expenditure any earlier.
A Possible Solution for Contractors
Where the allowance inserted in the BQ for compensable
extensions of time is felt to be inadequate, one possible
solution could be to strategically price the Contractors
overheads using a period which realistically refects the
likelihood of prolongation. However, this solution is not
problem-free and is fraught with risks:
How does a Contractor assess whether a Contract will
ADR Digest 3
... the Contractor is stuck with
his pre-priced rates for valuing
prolongation and there is no
mechanism for recovering
any shortfalls as Cost under
GCC Clause 63.
suffer compensable extensions of time? The Contractor is
required to blindly predict the timing of the effects of likely
delays which may or may not occur and their expected
duration this is a gamble which could potentially reap
fnancial windfalls or generate huge losses depending on
where the delays fall and the pricing strategy adopted.
The Contractor may have to load disproportionate sums
of money in relation to the overall Contract Sum into the
Contractors overheads.
Any additional monies which have been strategically priced
into the Contractors overheads would have to be taken
off other rates elsewhere in the BQ. However, the BQ rates
which have been reduced in value will no longer refect
the cost of the work being performed. This leaves the
Contractor exposed to further risks if the quantities of
such works are subsequently increased.






Conclusions
The methodology used for the pre-pricing of prolongation
costs in the Handbook is not favourable to Contractors.
Generally, they will be worse off that is worse off in terms
of recovery of Contractors overheads for prolongation and
variations. If the new provisions are to ... do away with the
time consuming and resource demanding Cost ascertainment
exercise associated with excusable delay ... ie. to bypass
prolongation Cost claims, then they appear ill conceived and
inadequately thought through.
Surely, the position has got to refect that it is equitable for
both parties to focus on ascertaining the actual additional
Cost incurred and for the Contractor to receive a fair recovery
on the basis of this actual additional expenditure.

What is the consequence of all of the above? Well, Contractors
who have not been able to strategically price the Contractors
overheads and/or that realise that their project will not receive
commensurate fnancial compensation for the delays will no
doubt pursue alternative avenues to ensure that they receive
their fair entitlements and this, in our opinion, will inevitably
lead to a heightened claims environment.
In conclusion, to quote one major contractor, the new
Handbook is reducing what was already a high risk bidding
process, into a blind gamble which is beyond the control of the
Contractor.
The December 2006 version of the Handbook can be
downloaded at:
www.cedd.gov.hk/eng/downloading/index.htm
For further information contact:
james.longbottom@adrpartnership.com
To quote one
major contractor,
the new Handbook is
reducing what was already
a high risk bidding process,
into a blind gamble
which is beyond the control
of the Contractor.
4 Winter 2007
Compromise: Recovering
the settlement that
shouldnt have been



By Timothy Hill, Partner, Lovells

From an early age children are taught that they cannot
get into trouble if they are not in the wrong, it would
therefore seem surprising if a party could face a substantial
award of damages even if they were not in the wrong.
However, the English Technology and Construction Court has
decided just that in the case of John F Hunt Demolition Co Ltd
v ASME Engineering Limited [2007] EWHC 1507, (2007) 23 Con
LJ T99. When put in these terms the conclusion is surprising
but in an environment where parties are encouraged to settle
their differences it is perhaps less remarkable.
In any complex construction project the successful completion
of the project is a team effort. It involves a complex inter-
relationship of parties with distinct obligations. Faced with
these challenges project sponsors and indeed increasingly
contractors look to package parcels of responsibility to third
parties. This can lead to diffculties when problems are
encountered or projects go wrong. In a typical scenario a
project sponsor will look to its contractor to be responsible
for damage which has occurred without wishing to become
involved in an inquiry as to which of a number of sub-
contractors or suppliers was responsible for the loss.
The contractor will look to its sub-contractors or suppliers to
indemnify it against the liability or to contribute to that loss.
However, very often the contractor will discover that the sub-
contractor or supplier will deny responsibility. In an ideal world
the contractor may seek to resolve the main contract and
sub-contract disputes at the same time, but this is not always
possible. There are a number of reasons for this, for example
the breadth of the obligations owed by the contractor to
the project sponsor may be such that if the contractor
cannot avail itself of the same type of argument as the
sub-contractor deploys, the contractor may consider the
sub-contractors arguments unsustainable or there may be
procedural or other obstacles preventing the issues being dealt
with at a common time in a common forum. In these
circumstances, a contractor is faced with a dilemma. It may
not wish to get drawn into long and costly proceedings but at
the same time it is likely to wish to ensure that it can rely
upon any settlement reached with the employer in its claim
against the sub-contractor.
The basic issue was considered in the well known decision of
Biggin & Co Ltd v Permanite Ltd [1951] 2 KB 314. In this case
Biggin supplied materials which had been sold to it by
Permanite to a third party. The materials proved to be
defective and as a result Biggin paid compensation to the
third party, it then sought to recover this compensation from
Permanite, basing its claim upon the settlement which had
been achieved with the third party. The Court of Appeal
considered that the settlement was relevant to the
assessment of damages at the sub-contract level.





















Firstly it stated that the settlement was to operate as an
upper limit on the level of damages which could be awarded.
Clearly it would be unreasonable to suggest that a contractor
who achieved a favourable settlement with a project sponsor
could seek to proft from this by making a full recovery against
its sub-contractor. The second more controversial conclusion
was that the settlement could be accepted by the Court as
the correct measure of damages if the settlement was a
reasonable one and somewhere around the level of damages
which would be awarded. The Court made the observation
that the party seeking to rely on the settlement could be
cross-examined as to its reasonableness and that in an
appropriate case the defendant might show that some vital
matter had been overlooked. This left open the prospect that
a sub-contractor could challenge a settlement both as to the
fundamental question of whether liability existed and as to
the level of the settlement.
One of a number of loose ends left at the conclusion of this
case was what happened if the sub-contractor contended
that the main contractor had no liability to pay the employer.
This problem was touched upon in a decision Comyn Ching &
Co Ltd v Oriental Tube Co Ltd [1979] 17 BLR 47. Here the
supplier challenged the contractors liability to pay the
settlement sum. The case turned largely on the construction
of the relevant documents and as a result the Court did
not have to decide the question of principle. Comment was
however made that a loss could be sustained if the claim arose
ADR Digest 5
The ... more controversial
conclusion was that the
settlement could be accepted
by the Court as the correct
measure of damages if
the settlement was a
reasonable one...















from the reasonable settlement of a claim which had some
prospect or a signifcant chance of success. Thus it could be
said that the settlement of a claim with a prospect of success
might be relied upon, but what if the contractor was plain
wrong in deciding to settle a claim?
The 8th Edition of Keating sits neatly on the fence, stating
that:

it will usually also be necessary to establish the claimants
liability to the third party and the defendants liability to the
claimant since evidence of the compromise is relevant only
to the measure of damages.

This issue however fell for consideration in John F Hunt
Demolition Co Ltd v ASME Engineering Limited. In the case the
defendant, ASME, was a sub-contractor engaged to undertake
welding work. Unfortunately, sparks from this work set light
to bitumen felt weather-proofng on another part of the
project, which caught fre. Hunt, who had engaged ASME,
received a claim from the employer and main contractor for
approximately 250,000. The sub-contractor offered
approximately 150,000 to settle these claims, which was
accepted. Hunt then sought to recover the sum from ASME.
For the purpose of the hearing it was accepted that a sum
in excess of 100,000 of the settlement sum could not
properly have been claimed by the employer against the
main contractor. Consequently, Hunt could not have been
responsible to pay the sum. ASME therefore resisted payment
of this sum to Hunt. ASME argued that the settlement with
The Court recognized
that the settlement of an
intrinsically weak claim in order
to avoid the uncertainties in
the expensive litigation may
well be reasonable.
the employer and main contractor was irrelevant or, at the
very least, unreasonable because Hunt had failed to realize
and/or act upon the absence of any liability. The Court did
not accept this argument, although left a possible way out
for ASME.
The Court said that in deciding whether a settlement sum
could be recovered the starting point would be a consideration
of whether the breach of contract caused Hunt to incur the
loss or damage suffered as a result of its decision to
compromise the claim. If the claim was (or was reasonably
considered to be) of suffcient strength reasonably to justify a
settlement and the amount paid in settlement was
reasonable having regard to the strength of the claim, the
settlement might be relied upon to justify the recovery of the
loss even if the claim would after further examination and
perhaps a trial have failed. The Court recognized that the
settlement of an intrinsically weak claim in order to avoid the
uncertainties in the expensive litigation may well be
reasonable. It said that this conclusion was entirely consistent
with the normal rules of foreseeability and remoteness of
damage, because it considered that it was reasonably
foreseeable at the time of the contract that a party may
settle the claim brought by another arising out of the same
subject matter, even if on a detailed analysis, liability may be
hard or even impossible to establish.
The Court considered the question of reasonableness was a
question of fact in each given set of circumstances. This fnal
observation allowed the Court to avoid a fnal determination
of the specifc issue in the case, because of the need for a
factual inquiry as to the circumstances in which the
settlement was made.
The effect of this decision is therefore to make it clear that in
appropriate circumstances a paying party may recover the cost
of a settlement even if on further analysis it was not liable to
pay the claim. If faced with a problem of whether to settle a
disputed claim it would therefore be prudent for a party to
take appropriate professional advice and to make sure that its
reasoning in concluding that the proposed settlement offered
a commercially attractive means of settling the case is
recorded. This case may be seen as further evidence of the
Courts willingness to foster a climate in which parties are
encouraged to arrive at a commercial resolution of their
disputes and differences.

For further information contact:
timothy.hill@lovells.com
6 Winter 2007
ADR Digest 7
ADR Analysis
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Inclement Weather
Some standard forms of contract do not list inclement
weather as an excusable event (see Figure 1). Therefore, the
contractor assumes responsibility for both the fnancial and
programming effects of inclement weather.





















What happens then if there is delay caused by inclement
weather within an extended period after the original date
for completion? The contractor will not have made any
allowance for such delays and the Contract Administrator
(CA) is superfcially not empowered to grant extensions of
time if inclement weather is not listed as an excusable event.

The answer is simple. Delays caused by inclement weather
in an extended period should be considered as part of the
effects of the primary delaying event (ie. the excusable event)
for which extensions of time have been or should be granted.
Generally, the principle is that inclement weather in an
extended period qualifes for further extensions of time if it
was incurred due to the consequential or knock-on effects of
Excusable
Event
Compensable
Event
HKIA/HKICM/HKIS
Standard Form
of Building Contract,
Private Edition

Yes
see Clause 25(b)
& (c)

No
Swire Properties Ltds
Standard Form
of Building Contract

No

No
Governments GCC
for Civil Engineering
Works
Yes
see Clause 50(1)(b)(i),
(ii) & (iia)

No
KCRCs GCC for
Civil Engineering
& Building Works
No
see Clause 45.4(d)

No
Figure 1: Inclement Weather Provisions in Hong Kong Standard
Forms of Contract
an excusable event. Authority for the principle can be found
in the Canadian case of Ellis Don v The Parking Authority of
Toronto (1978).

Most standard forms of contract also provide that the CAs
assessment of an extension of time should be fair and
reasonable, which should take into account all of the effects
caused by an excusable event including inclement weather.

Generally, a delay caused by inclement weather is not a
compensable event giving rise to additional payment or
recompense. However, based upon the principles established
above, the contractor may be entitled to recover the
additional costs incurred due to delays caused by inclement
weather, which costs were incurred due to the knock-on
effects of a primary excusable / compensable event.
EVgicZgh^c6aiZgcVi^kZ9^hejiZGZhdaji^dc
8 Winter 2007
CIArb Young Members Group
Social Evening


ADR Partnership was proud to be a sponsor of the Chartered
Institute of Arbitrators Young Members Group social gathering
held at Grappas Restaurant, Central. Great company, good food
and a plentiful supply of drink was the ideal recipe for a most
enjoyable evening.

ADR Partnership Limited
17A Seabright Plaza 9-23 Shell Street North Point Hong Kong
t: (852) 2234 5228 f: (852) 2234 6228
e: info@adrpartnership.com www.adrpartnership.com
ADR Partnership Limited and the contributors to ADR Digest do not accept any liability for any views, opinions or advice given in this publication.
Readers are strongly recommended to take legal and/or technical specialist advice for their own particular circumstances.

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ADR News
EVgicZgh^c6aiZgcVi^kZ9^hejiZGZhdaji^dc
Expanding the ADR Team


It has been a busy few months for us at ADR Partnership and we
are pleased to announce that the following consultants have
joined the ADR team:

Derek Dixon
FRICS
Managing Consultant
Derek is a Chartered Quantity
Surveyor with over 40 years
experience in commercial and
contractual matters. He has
acted as an expert witness in
arbitration and High Court
hearings on numerous occasions
and has extensive experience working at a senior level in the
preparation and defense of contractual claims.
Travis C K Ling
BBuild MFM MRICS AAIQS
Consultant

Travis is a Chartered Quantity
Surveyor currently studying for
a degree in Law. He has a wide
range of civil, infrastructure,
building and building services
experience having advised clients
on commercial and contractual
matters on some of the largest projects in Hong Kong and Macau.
Kaymond H C Lam
BEng(Hons) LLB(Hons) MSc DIC
MHKIE MICE CEng PCLL
Consultant

Kaymond is a Chartered Engineer
with a degree in Law and has also
completed the Post Graduate
Certifcate in Laws. He has
provided a broad range of services
on various engineering projects in
Hong Kong, including providing support in both arbitration and
mediation proceedings.
Further details of all our consultants and directors can be found
on our website: www.adrpartnership.com
Chartered Institute of Arbitrators Young Members Group
Spot the Young Member!
Based in Hong Kong, ADR Partnership Limited is a dynamic practice
of construction professionals providing specialist commercial and
contractual services to the construction industry.
If you would like to discuss any of the articles published in this Digest
or your project requirements, please contact James Longbottom,
Patrick ONeill or David Longbottom at ADR Partnership Limited on
(852) 2234 5228 or e-mail us at info@adrpartnership.com