Design to Budget Clauses in an Inflated MarketJuly 2022
Tender prices on construction projects in Saudi Arabia rose by an average of 4.5% in 2021. Given the strength of demand for construction materials, the shortage of qualified local contractors, dependence on imported building materials particularly from China and Europe, we now know tender price inflation is expected to be north of 7% in 2022.
With such steep price increases over the last two years, and continued economic volatility creating difficulties in the supply of labour and raw materials, Consultants need to be aware of the significant risk that price escalation can cause them as a result of Design to Budget obligations within their contracts.
Design to Budget clauses make the Consultant responsible for managing the design process so that the cost of construction of the final design is within the Employer’s construction budget. Therefore, it would be sensible for Consultants to check their insurance policies to see whether they are covered for any Design to Budget obligations imposed under their contracts.
Typically, a Design to Budget clause will require the Consult to:
- (a) consult with the Employer to establish what the construction budget actually is;
- (b) design with the intent to stay within the budget advised;
- (c) update the cost estimates as the design progresses (including in respect of any Change instructions received) and inform the Employer of any variances from the budget advised;
- (d) obtain the Employer’s approval of the design at each phase before moving on to the next one;
- (e) once the final design phase is approved, if the lowest qualified tender is over the Employer’s budget the owner may require the Consultant, at no additional charge, to perform redesign services to bring the cost within the budget.
Obviously, it is important that the parties are cognisant of their mutual obligations in respect of the budget. Naturally, the budget will be impacted by design decisions being made by the Employer, but equally, the Consultant has a duty to warn the Employer where those decisions affect the budget so as to ensure the parties are both agreed on what the final construction budget will be.
If either of the parties fail to reasonably engage with their obligations in respect of the costs to design, the Consultant may be at risk of having to undertake a significant amount of re-design work at no charge to the Employer. Equally the Employer may be at risk of either not receiving a design that is in line with its expectation as a result of value engineering activities that need to be undertaken to reduce the cost, or in the worst-case scenario, it could be left with a design that is not useable as it is too expensive to construct.
Accordingly, some of the key risks to be managed are as follows:
- Set the Budget
An Employer’s design aspirations will naturally be limited by what they can actually afford, and therefore, the budget needs to be understood from the very outset of the party’s design partnership. There is no point in the Consultant being asked to propose, or proposing, flamboyant design options if the costs to construct such a design does not fit within Employer’s construction budget or align with the Employer’s commercial goals for the project.
- Update the cost information
Understand that the costing for a design phase often follows a few weeks after the design work on a particular phase is actually completed. While parties may be keen to proceed to the next design stage without cognisance of the budget, this places both parties at risk.
Accordingly, parties should consider:
- (a) whether it is in the interests of the project to submit the costing alongside the design submittal for approval, or whether it is possible to submit the design for approval, and then submit the costing information afterwards, with the knowledge (or agreement) that the design can be amended to incorporate any value engineering activities that may be required to bring the design back within budget.
- (b) Whether the Employer is required to provide separate approval in relation to the costings which serve as an agreement by the Employer as to the construction budget. This will allow the parties to move forward with a clear idea of the expectations as to the construction budget in real time.
The final risk is in relation to price escalation. This escalation could occur between when a construction budget is initially set and when the design is completed. Or between the time the Employer receives and approves the final design, and when the Employer takes the design to tender.
Note here that a huge amount of the cost of a project is in the shell and core, which are elements of a design which are typically settled very early in the design process. Therefore escalations in costs for raw materials such as concrete and structural steel during the course of a design can have significant impact on the overall cost of construction which may impact on the finishing activities.
For Consultants, price escalation clauses can help to mitigate some of the risk posed by the unpredictability of the market, as they allow for some of the economic risk associated with the project to be absorbed by the Employer.
The reality is however that most contracts that we see coming out of the Kingdom do not include any such escalation allowance. In fact, many of the contracts that we see also include an obligation in the Consultant’s duty of care for it to use “foresight” in the execution of the Services. Employers may exploit this clause to argue that price escalations should have been foreseen and therefore factored into the design process.
- Limitation on Re-Design
As set out above, once the final design phase is approved, if the lowest qualified tender is over the Employer’s budget, a Design to Budget clause often includes a requirement that the Consultant is to perform redesign services to bring the cost within the budget.
This is in essence an unknown scope of work which places the Consultant at significant risk. With risk, we often see a price attributed which is ultimately borne by the Employer.
Accordingly, it may be in the parties’ best interest to consider whether some sort of language should be included to limit the Consultant’s potential exposure for redesign work.
The parties may consider allowing the Consultant to charge for the work that the Consultant may be required to undertake to bring the design back under the budget in circumstances where the Consultant has warned the Employer that the budget is too low in light of the design decisions made by the Employer, or that the tender prices are likely to be higher than budgeted as a result of cost escalations.
Alternatively, if the design services are to be at no charge to the Employer, the parties may consider limiting the amount of re design work to be undertaken by the Consultant to either a set number of hours or set number of re-submittals.
In the wake of significant tender price inflation, we expect to see an increase in the number of claims brought against Consultants in respect of designs prepared to construction budgets that may no longer be applicable or realistic in this market. Whilst Design to Budget clauses are a necessary tool that allow Employer’s to manage both design expectations and construction costs, their use should be managed carefully by both parties given the potential legal and practical consequences of their enforcement.Download PDF