A guide to valuing variations

Disputes in construction are typically centred on payment with differing views as to the value of work completed. Variations play a key role in this as the contract price is agreed before the contract is executed. However, with contracts laying down the process for acknowledging a variation and the method to make an assessment of the impact, within their terms and conditions, how is it possible to end up in a situation where a disagreement has built up to the point that it requires contractual resolution?

Disagreements can occur for several reasons, such as the value of the variation assessed by the client not covering the contractor’s actual costs, a perception that some of the costs incurred are not permissible due to the contractors own failings, or that a contractor has incurred costs that are not related to the instructed works.

A JCT Standard Building Contract with quantities describes variations as “the alteration or modification of the design, quality or quantity of the Works” including additions, omissions or substitutions. It also states that a variation occurs whereby the employer imposes obligations or restrictions except for those agreed as forming part of the original contract structure.

Construction is generally a fast paced environment where decisions are made in real time to expedite the risk of on-going preliminary costs. If an instruction is received to undertake a variation, the pressure is on to start immediately and provide a quotation later, but this is often a recipe for trouble as retrospective analysis of the value of works can lead to a mismatch with the cost incurred.

Good practice for both parties is to be clear on what is being instructed and check understanding of budgets beforehand. Contractors should provide quotations and clients should make assessments before starting any works in order to avoid ambiguity.

How does JCT (and other standard forms) tell you to value variations?

There are variances between the differing options available when contracting e.g. for a target cost contract the valuation for a compensation event is to use defined costs, either on a forecast or incurred basis. There are instances whereby a split between the two occurs with the dividing point being the point of instruction to provide a quotation.

However, all standard forms of contract have their own procedures for valuing variations whether they are additions or omissions. They broadly follow similar principles whereby they are to consider if:

• Contract pricing schedules (i.e. bills of quantities) can be used to price the variation. Is there an exact rate that matches the type of work?
• In instances where the existing rates are not of a similar nature, can they be used as a basis for producing a new rate? For example, similar in nature but dimensions are different. Can the rates be broken down, amended and built back up?
• If the works are not listed they should be priced as a new item entirely.

In NEC ECC Options B and D contracts, the use of a bill of quantities for pricing compensation events is in the form of a changed rate, a changed quantity or a changed lump sum where work is of a similar nature. Where a new priced item is required this is compiled in accordance with the method of measurement as stated in the contract.

In terms of JCT contracts, the Contractor is obligated to carry out instructions unless they make reasonable objections, with such objections being listed in the contract e.g. it is not their area of expertise etc. Note also, that if the contractor does carry out additional work without an instruction, they run the risk of not being paid for the works. However, assuming they have been instructed, variations are valued by agreement between the employer and contractor, or alternatively the architect or contract administrator accepts them.

Alternatively, the quantity surveyor can use the Valuation Rules where the relevant rates and prices are already listed in the contract and they are for work of a similar nature. Or, in the absence of similar rates or prices, they can demonstrate they have valued the works at fair rates and prices. If either of these options is not available the variation can be valued on a daywork basis.

The valuation rules and what do they mean

The valuation rules are a reference to JCT Clauses 5.6 to 5.10 in which it is set out how to value variations and what criteria is used to differentiate between the assessments. For example, Clause 5.6 for measureable work describes that where work is of a similar character to work in the contract bills and is executed under similar conditions, the original rates and prices should be applied.

This is generally where disagreements can arise over interpretation of the ‘similar character,’ as contractors will try to favour a new rate or to price the variation on a daywork basis. They might not want to value variations using only competitively priced rates, whereas for the client the obvious preference for them is to use the market-tested rates.

Where the work is similar, but there is a significant change in conditions or in the overall quantity, the rates and prices in the contract bills can still be used, but a fair allowance for the change should be applied. This approach is reasonable as long as the ‘fair allowance’ part is agreed by both parties. If the work is not of a similar character to that contained in the contract bills then new fair rates and prices are to be applied.

Alternatively, the works can be valued on a daywork basis, but this is generally seen as the least favourable option for the client on the basis that the contractor does not have to work to an output rate i.e. if they are unproductive the risk of increased cost resides with the client. For the contractor, using daywork is low risk for them and dependent on the rates they listed in the contract for daywork could provide a higher return than using a rate from the contract bill.

Whilst some forms of contract, namely NEC ECC, refer the contractor to demonstrate the effect of a compensation event upon their planned completion date in order to be compensated for time related costs, the JCT contract operates whereby claims for extensions to the contract period are notified and evaluated under separate conditions of contract. The use of ‘loss and expense’ provisions are put forward by the contractor on the basis that any payments are without prejudice over contractual provisions the contractor may have.

The issue here is that without interlinking the two, it puts the client at a disadvantage in that the final value of works, including all claims for loss and expense related to extension of time, might not be known until later, making financial management difficult.

What if the work is similar to an item in the schedule of rates but slightly different?

According to the JCT valuation rules, you can utilise the existing rate as long as you make a fair and reasonable allowance for the change.

For other forms of contract such as FIDIC, which is ICE based, using the contract rate as a basis you would remove the overheads and profit, which is a percentage based addition with the percentage stated in the contract, before amending by way of omission or addition the relevant material element, alter the labour and plant accordingly before adding back the overheads and profit. The allowance for risk would typically be pro-rata from the overall risk allowance included in the contract sum. You can then add the components part back together and use the rate to value the variation.

The issue with such an assessment is that it does not take into account current market conditions or actual project constraints. From a client’s perspective, they would argue the rate must have considered these points as it is a tendered rate for the project in question. However, the contractor may state that it is simply a library rate and was not intended for use in the way of valuing subsequent variations.

Be mindful that some contractors may strategically price the works by making a guess at tender stage what variations are likely to occur and provide disproportionately high rates for those items. This is notoriously difficult to spot when you consider that some contract bills can run on dependent on the scale and complexity of the works. However, pricing works in this way is also a risk for the contractor. If their gamble does not play out as expected and the variations occur elsewhere, and the applicable rates are lower than average, then any argument they may have not to use the rate will not have much contractual weight behind it.

The risk of loading certain rates but lowering others to achieve an overall price is played out in the case of Henry Boot vs Alshom Combined Cycles. The contract was ICE and following a dispute as to whether a rate that was deemed erroneous could be used to value variations, it was upheld at the Court of Appeal that use of contract rates is as the contract intended and are not to be adjusted, even if proven to be erroneous.

The classic construction law textbook “Keating on Construction Contract” 10th edition states that, in terms of similar conditions, the demonstration of facts in the variation in question should be drawn out to establish if a contract rate is similar to the variation and can be used as the basis for valuation:

“dissimilar conditions might, it is suggested, include physical site conditions such as wet compared with dry, compared with low, confined space compared with ample working space and winter working compared with summer working, where the contract documents show that the Bill prices were based on such conditions.”

The point here is that it’s important to establish what is meant by slightly different, as the quantity or type of material may be similar but what about the conditions they are being constructed within?

Can or should I pro rata rates?

Using a pro-rata assessment works well for time related items where, for example, the contractor has claimed they are 50% completed, but from an analysis of the programme you calculate they are only 40% complete, therefore you can pro-rata their valuation accordingly to avoid overpaying them.

However, for permanent work rates, proceed with caution. For example, if the width of blockwork increases, then simply adjusting the rate pro-rata for the increase will adjust all elements of the rate i.e. labour, plant, material, risk, overheads and profit. Whereas in reality you will likely only need to adjust the material element. By using a pro-rata assessment, you could in fact end up overpaying.

When to use dayworks

If the works are of an incidental nature, generally short term and where it does not make sense to adjust contract rates as the works are of an unforeseen nature e.g. you have come across an obstruction that requires breaking out in order to continue with the permanent works, then using dayworks would be a logical way to value the works.

Daywork records usually list the plant, labour, materials and ancillary items used to carry out the works. In many cases the records are signed “FRPO” or for records purposes only, on the basis the client does not want to authorise payment on a daywork basis, but by signing they are acknowledging that the work was carried out and the hours and resources claimed were indeed used. However, when it comes to valuation of the works, a signed daywork sheet does not detract from the existing contract provisions as to how variations could be valued i.e. using existing rates, new rates or pro-rata of existing rates and dayworks.

Note that if you do not intend to pay on a daywork basis, moving to a different method of valuation after the completion of works could naturally lead to a dispute. If you are intending to use dayworks, it’s important to agree this is how payment will be made.

Image credit: Photo by Ross Findon on Unsplash

About Dean Suttling

A member of the Royal Institution of Chartered Surveyors, Dean has twenty years of experience in commercial management and quantity surveying, undertaking roles for contractors, clients, and consultants.