Provisional Sum – When and how should you use it?
Provisional sums are perceived as difficult to manage, to understand and to execute. Should you only include them in the overall price as a last resort?
Whilst they are appealing as lump sum items, Provisional Sums are in effect risk items where the scope cannot be fully itemised for a variety of reasons. This could be due to a perceived lack of design in the moment or if the level of uncertainty is too high for a contractor or sub-contractor to commit to a price.
How do Standard Form Contracts Define Provisional Sums?
To impose some structure to the world of Provisional Sums, almost all forms of standard construction contract provide a definition as to the classification of a provisional sum as either defined or undefined.
Since the JCT adopted the RICS New Rules of Measurement, a defined provisional sum is broadly described as an item where:
the nature of construction is understood, that quantities can or will be provided based on the indicated scope and that any restrictions are understood.
If a Provisional Sum can be classified as defined then the contractor will be deemed to have made some allowance in terms of schedule and associated running costs (preliminaries) for the sum in question.
In contrast to this, undefined Provisional Sum are those where the employer is unable to provide details to enable the contractor to provide a price with any level of certainty. If an undefined Provisional Sum is used, it should be noted the employer will be liable to pay for the full final cost including any programme impact assessed in line with the conditions of contract.
ICE Conditions of Contract
In other contract forms, such as ICE Conditions of Contract, the term provisional sum is defined as:
“means a sum included and so designated in the Contract as a specific contingency for the execution of work or the supply of goods materials or services which may be used in whole or in part or not at all at the direction and discretion of the Engineer”.
There are some important points to note here such as it is the Engineer, not the contractor, who has the discretion to use the Provisional Sum. Also, it is described as a contingency, but it is silent on whether it is deemed to include programme effect. If a Provisional Sum is put into operation by the Engineer, then the onus will be on the contractor to make a claim for an extension of time through the normal contract provisions. It’s therefore prudent for the contractor to make a suitable allowance when determining the Provisional Sum amount to save protracted contractual issues later down the line.
In NEC ECC forms of contract there is no description or definition as to what would classify as a Provisional Sum. With a clear compensation event procedure stated in the contract, along with the requirement to operate in a spirit of mutual trust and co-operation, the general consensus is that if the scope of works is so unclear that a price cannot be provided with a level of certainty, they should be left out until they are known. If the employer wishes to include a sum in the overall price, they could include as a risk on the risk register and then once the scope is clear instruct the works as a compensation event.
Here, Provisional Sums operate in a way that the final price and schedule effect, (both positive or negative) are principally shared between the employer and contractor where it is mutually agreeable for the employer and contractor to accept the inclusion of a Provisional Sum in the contractors or sub-contractors price return.
What’s the difference between Defined and Undefined Provisional Sums?
Undefined Provisional Sums
To expand further on undefined Provisional Sums, they are included in a contractor’s overall price, but this is only to make allowance for the work that could be required. They are a best guess based on the information available which may be scarce. The employer should bear this in mind, as they are unlikely to be able to hold the contractor to the sum quoted.
Also, allowance for undefined Provisional Sums are not included in the programme. This means that no allowance will have been made to their time related elements and, once details of the Provisional Sum are known, the effect on programme will need to be included in any final agreement.
Defined Provisional Sums
Defined Provisional Sums are where the contractor has been provided sufficient detail to make allowance for them in their price and programme. This detail could include a certain level of design, an understanding of construction phasing, likely quantity and any specific restrictions are known. However, if all of this is provided, it leads to the question: why include a provisional sum at all as opposed to simply pricing the item? The reason may be that whilst there is enough information against which the contractor can price, there may be a high level of uncertainty. For example, the finished product may not be selected, the conditions are too unknown, or the final quantity may differ.
However, by including defined Provisional Sums, there is a basis upon which to manage any change and the contractor has included time allowance within their overall programme. As a result, the exposure to budget and time is minimised for the employer.
An example of a defined Provisional Sum could be for making the contractor responsible in dealing with queries from a planning application. There could be either fifty or eight hundred queries, but the contractor may wish to price what they consider reasonable or appropriate in a defined provisional sum.
The pros and cons of provisional sums
For the employer, the advantages of using defined Provisional Sums will be their ability to pass risk onto the contractor. This is because the contractor will be deemed to have made sufficient allowance for the effect on programme and ensuing running costs. This will negate the need for the employer to establish impacts to the programme and agree any extensions of time later down the line in the event they decide to instruct the Provisional Sum.
For the contractor, a Provisional Sum is intent from the employer to undertake additional works. The opportunity is to work with the employer to develop the scope and price enabling the employer to instruct the works. Also, if they keep good contemporary records of the work undertaken, there is a good chance they will recover all of their direct costs for a defined Provisional Sum or their entire actual costs and time related costs for an undefined Provisional Sum.
The disadvantage of Provisional Sums for the contractor is that they are taking on more risk, in terms of defined sums, where they are deemed to have already priced for the time to carry out the works in their programme. If the allotted time proves to be insufficient, this could lead to some adversarial contract administration to recover their position.
Similarly, the contractor cannot rely on the contract value at award if it includes Provisional Sums as these may be omitted by the employer and awarded to others. Therefore, the contract may not appear as rewarding as first thought. From an employer’s perspective they should consider that in the case of JCT the Provisional Sums (defined or undefined) will form part of the scope. If the employer decides to omit the provisional sum and award works to another contractor, they may face a challenge for a loss of profit claim from the incumbent contractor.
The employer should be aware that inclusion of undefined Provisional Sums means they could be liable for the entirety of the final costs and programme effect. There will be contract provisions that could limit their exposure in terms of non-payable costs. For example, with reference to the ICE Conditions of Contract which states that the “Contractor receives payment for only the work done to which the Provisional Sum relates” and the ability to make their own assessment. However, good practice is to work together to resolve such issues beforehand by agreeing a quotation for the work upfront.
How to get a firm number at the outset or as early as possible
Whilst the RICS new rules of measurement 2 refer to defined or undefined Provisional Sums, other forms of contract may not (such as ICE or bespoke forms). If contracts simply refer to Provisional Sums in the pricing document, then early agreement on the costs is preferable.
Before instructing their use and entering negotiations, the employer should understand the sequence and timing of the works in question, including any lead in times for specific items. Failure to understand the timing of works could lead to unnecessary additional costs. Instructing the contractor to provide a quotation is advantageous and could avoid disputes in agreeing the value of works post completion.
Provisional Sum Adjustment
The general concept of Provisional Sums is they are omitted under instruction from the employer and replaced with the actual cost of the work if instructed. If the Provisional Sums are defined, the actual cost of the work plus will be reimbursed but there will be corresponding time related preliminaries as this will be deemed to be included in the overall price and therefore already paid for.
If a Provisional Sum is undefined, the onus still remains on the contractor to demonstrate cause and effect when determining entitlement to additional time related costs and their direct costs are to be fully substantiated.
Contractual and Legal position on operating Provisional Sums
If the contract contains undefined Provisional Sums and the employer instructs it, they will have to expect to pay the full costs of the works including full programme entitlement including delay costs, alleviation from damages if they apply plus the full direct costs and fee. The exposure here outweighs the normal mechanism of simply instructing and agreeing the costs of a variation to the works.
Disputes may arise where, in the employer’s opinion, the contractor has not worked efficiently or effectively in carrying out the works and therefore is not content to simply pay the costs incurred. They may decide to make their own assessment of the contractor’s costs and establish this as the final sum payable.
Case law linking back to the above
In the case of “Midland Expressway Limited –v- Cambba, 2006, the contractor argued that no allowance was made in the conditions of contract to provide for Provisional Sums to be omitted or to be adjusted according to the value of the work actually carried out. This argument was on the basis that the value of the Provisional Sum fell in their favour i.e. the sum amount covered the cost of the work undertaken and more which lead to them arguing they should be paid the Provisional Sum in full.
After making it all the way to the court of appeal the judge ruled that “Provisional Sums were by definition in the Contract only payable at all if and to the extent that the Employer so instructed.” It is always worth reviewing the contract to ensure the intended method of Provisional Sum management is stated and unambiguous.
Lord Justice May who ruled on the case above described Provisional Sums as:
“… usually included as a round figure guess, it is included mathematically in the original contract price, but the parties do not expect the initial round figure to be paid without adjustment. The contract usually provides for the provisional sum to be omitted and an appropriate valuation of the work actually carried out to be substituted for it.”
This ruling aligns to the contract and industry practice as described above.
Conclusion and take-away thoughts
With all the uncertainty around Provisional Sums, you might be left thinking what is the point of including them at all as they are perceived to be so problematic. Certainly, in the case of undefined Provisional Sums, this would appear to be the case as the risk of programme and cost uncertainty resides entirely with the employer but with the ability to make their own assessment this is not infallible.
If undefined Provisional Sums are included in the contractor’s price, the employer should consider making a suitable allowance for the risk of exceeding the allowance in their risk register.
However, defined Provisional Sums are more appealing as the risk is shared, although bear in mind that a contractor may build in a disproportionate amount of risk into their price and programme to account for their share of the risk.
If the employer has a clear intent on how they wish it to operate then making the contract clear in how it operates is important. The same can be said for Provisional Sums. Ensure the contract is amended such that any ambiguity or confusion is removed, and the provisions operate correctly.