Construction focus: pricing in target cost contracts

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An employer was held liable only for “reasonably and properly incurred” costs under a bespoke target costs contract which went seriously over budget.

The Technology and Construction Court recently commented on the costs that an employer is required to pay under a target cost contract.

The court held that the employer was not expected to foot the bill for all costs incurred by the contractor, but only for costs that were "reasonably and properly incurred".

Pain/gain

Target cost contracts typically contain a “pain/gain” provision that measures the contractor's performance against a pre-agreed target price. If the project comes in under the target price, the contractor will take a percentage of the savings. If the project comes in over the target price, the contractor will bear a percentage of the costs.

The building contract in this case was bespoke, and was unusually worded in that, if the project went over budget, the contractor was responsible for the overrun up to a maximum limit of £50 million over the target price. Once that limit was exceeded, responsibility for project costs passed back to the employer.

Reasonably and properly incurred

The project ran substantially over budget and the overruns exceeded the £50 million for which the contractor was responsible. The contractor claimed that any costs it suffered over the £50 million should be paid by the employer, however the costs had been incurred. An arbitration was brought between the parties at which the arbitration panel decided that the employer should only have to pay the “reasonably and properly incurred” costs, as defined in the contract. The contractor made an application to the court for permission to appeal this interpretation of the contract. The court refused the application.

Not surprisingly, the court did not consider the interpretation of a bespoke contract to be a question of general public importance. Despite this, it will be interesting to see the extent to which the courts will apply the principles in this judgment to the wording of standard form target cost contracts.

AMEC Group Limited v Secretary of State for Defence (2013).

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