Executive Summaries

@DLS
for the practitioner

… Consultancy Volume 4 Issue 1 : April 2004

MITA(P) No. 051/01/2004

A Davis Langdon & Seah Consultancy Information Sheet

Guaranteed Maximum Price Contracts

Cost overruns in construction contracts are as ubiquitous as the hard hat and any procurement process
which can limit such exposure to a financial cap and give certainty of price will find favour with clients.
The answer lies in GMP contracts which offer an attractive proposition for increased cost security provided
the definition and allocation of risks are clearly and fully understood by the parties.

INTRODUCTION

Getting a building built involves an amalgam of activities and choices and more choices and about
the prioritisation of these key factors – project characteristics, risk allocation, cost certainty, timing
and quality.

However, for a myriad of reasons from delays to fast-track pressures and poorly prepared briefs at
the outset of the project, upward adjustments in price from the original contract sum are endemic in
construction contracts which are already unhelpfully complex. Not surprisingly, client-driven
initiatives have resulted in the drafting of contracts with provisions which seek to cap financial
exposures for greater certainty of price.

WHAT IS A GMP?

There is no universally accepted and common definition for a guaranteed maximum price (GMP)
contract, yet it is something which everyone appears to be aware of but for which it may also mean
different things to different people.

‘Price cap’, ‘no upward price adjustment’ or ‘prices cannot be exceeded’ – these are some of the
expressions used to describe GMP. Interestingly, a legal commentator writing in a technical journal
had this cautionary remark about GMP:

Just as the Holy Roman Empire was neither holy nor Roman, parties to a guaranteed
maximum price contract should realise that price is not really guaranteed or maximum.

If the ‘guarantee’ in GMP is a bit of a misnomer, what then is a GMP contract?

A GMP is effectively a lump sum price for a project where the amount of money that a client is
contractually obliged to pay is the maximum price. All construction contracts provide for the
allocation of risk between the contracting parties. In GMP contracts, the risk of the final cost
exceeding the price cap and cost overruns or increases is shifted on to the contractor whose
entitlement to payment is capped at the GMP level.

GMP is a not a standard form of contract conditions but a concept fulfilled by a set of conditions
that can be introduced and used in conjunction with any standard form such as the SIA Standard
Form, JCT Standard Form with Contractor’s Design, or the REDAS Design and Build Standard Form
and even with public sector contract forms.

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Guaranteed Maximum Price Contracts

There is no standard form of contract and neither do publishers of such forms produce GMP
supplements to be used in conjunction with the main suite of printed conditions which can helpfully
shed some meaning to the term.

HOW DOES GMP WORK?

GMP contracts can work in a variety of procurement routes – from the more orthodox traditional
approach to modified traditional with contractor-designed portions and design and build
arrangements. Clients need to understand their procurement strategies and how these can be fitted
around each project.

The key factor in a GMP contract is the price cap – with the risk of the final cost exceeding this cap
falling on the contractor. Quite understandingly, GMP contracts give cost certainty – something
which clients and funders seek in order to limit their financial exposure.

If the work is completed

for less than the GMP, the Overrun – who pays ?
contract may provide for
Contractor
some financial incentives,
usually by way of a GMP
mutually agreed shared
savings scheme (Figure 1). Saving – whose benefit
benefit ??
Owner; or
Figure 1: Contractor; or
Basic Concept in GMP Contracts Time Owner + Contractor

Such an arrangement where any savings generated are shared between the client and the
contractor not only encourages teamwork but also incentivises the contractor to look at value
engineering alternatives and cost effective design solutions garnered from his experience on
buildability and best practice construction methods to make savings and reduce overall contract
cost.

Different approaches to GMP contracts are possible. The more common way involves a two-stage
process where potential pre-qualified tenderers with experience of GMP contracts are invited during
the first stage to submit budget prices based on outline design information, programme and
preliminaries together with overheads and profit. At the second stage, the contractor is selected
based on a combination of financial and technical offers, competence, quality and value criteria,
timing and detailed pricing of his own works and the major subcontracts. The contract price and
GMP are then confirmed and fixed.

The control of the design team can either be retained by the client to administer the contract (as in
the case of traditional GMP contracts) or novated, partially or in whole, to the successful contractor
to develop the design.

Typical contract documentation will include the employer’s requirements setting out the following:

• Work scope and performance-based specifications for any contractor-designed portions.

• Design intent drawings.
• Specialist works (under the contractor) to be packaged and tendered to trade contractors.
• Provisional sums.

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Guaranteed Maximum Price Contracts

The clearer the definition of work scope, the less likelihood of disputes and misunderstandings later
on what is or is not included in the guaranteed price.

The contract will provide for the design intent to be developed and the works constructed for the
agreed lump sum which forms the GMP. Unless there are client-generated scope changes, there will
be no upward adjustment of the price and the contractor’s entitlement is capped at the level of the
GMP.

GMP PRINCIPLES

A GMP contract bears the hallmark of cost certainty and can best be described as a lump sum
price with very limited rights to adjustments for variations. Once the GMP has been fixed and
agreed, only client required changes and changes as a result of legislation or statutory requirements
affect the price cap. Such changes are usually termed GMP variations. The contractor is responsible
for all time and cost effects from any design development, coordination and integration of the
design with various elements of the work, and the quality, flow and completion of detail design for
construction.

Just as the GMP is capable of adjustment to reflect GMP variations, there must also be a mechanism
to adjust it downwards when the scope of work is reduced. The distinction between savings and
omissions must be clearly stated to avoid arguments especially where the contract provides for a
shared savings scheme and the contractor unwittingly gains a benefit.

Where the employer’s requirements include work for which provisional sums are allowed, the
contract must provide that such adjustments are not to be treated as GMP variations. The risk of any
overrun between the original provisional sum and the awarded value is assumed by the contractor.

GMP BENEFITS AND CONCERNS

The greatest attraction with GMP contracts is obviously certainty of price given that any upward
adjustment only relates to changes in scope and legislative and authority changes. The risk of cost
overruns caused by design development, late or inadequate design detailing information,
undescribed and indispensably or contingently necessary work is included within the GMP.

Another benefit is in the involvement of the contractor in design development. The contractor’s
input stimulates value engineering, buildability advice, cost effective design improvements and use
of specialist construction systems and techniques.

Successful GMP contracts can also mitigate much of the common problems associated with
traditional procurement such as dichotomy of objectives from separation of design and construction
processes, unclear lines on responsibilities and liabilities and where each post contract change
arising from uncoordinated and incomplete design and detailing invites a time and cost claim.

Difficulties in ascertaining what falls as a GMP variation is viewed as the biggest bone of contention.
Without question, what is required in GMP contracts is a clear variation protocol to deal with change
orders submitted as potential GMP variations. The variation process will require strict compliance with
a notification procedure and provide that no variation shall be deemed as a GMP variation unless
raised in a particular form, manner and within a timescale, and supported by detailed claim
documents showing the cost and time implications to justify adjustment of the GMP contract sum.

Another area of concern is disagreement on what has been included in the agreed GMP. Disputes
over design development items presented as scope changes can be minimised by having a clear
definition of the design intent and scope of work articulated in a comprehensive employer’s

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Guaranteed Maximum Price Contracts

requirement document. Agreeing the GMP too early based on sketchy, incomplete and nebulous
design information is risky and the client and the contractor need to be aware of this.

CONCLUSION

While the prospect of price certainty appears alluring and attractive, GMP contracts must be
approached with care. Under professional guidance, GMP contracts offer good value for money
and in particular, for clients who have to develop viable schemes within tightly controlled budgets.

GMP contracts can be made to work effectively with careful thought using a good professional
team with experience in such type of contracts to put together the contract structure and
administrative arrangements and procedures. Above all, clear legal drafting and unambiguous
words are essential to accommodate GMP contracting in the established standard forms if there is
to be no misunderstanding of liabilities.

DLS TPI is a measure of the comparative tender price movements based on the projects handled by Davis Langdon &
Seah Singapore Pte Ltd. TPI reflects the tender price level of contracts let out over the years. Other than material and
labour costs, TPI takes into account the element of competition, risk and profits. Besides the DLS TPI, two other
established indices are the Building and
Tender Price Index (Base Year 1988)
150 Construction Authority Tender Price Index (BCA
146 143 144 TPI) and CPG TPI.
140 138 DLS
137
134 133
137 137
BCA The tender prices for 1st Quarter 2004 registered an
133
130
130

128
135 136 130
increase of approximately 3%. This increase is due
128
129
127
122
120
124
mainly to the demand for metals worldwide which
120
117
116 115 115 115 has impacted on construction costs.
113 113
110 112 112
114
116
Tender prices are expected to continue to be on the
100 uptrend for 2nd Quarter 2004 until the global demand
100
100
88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 1Q 04 2Qp for metals stabilises.

Davis Langdon & Seah Singapore Pte Ltd (DLS) provides integrated management services for construction projects
comprising cost management, project management, legal support, specification consulting,
cost engineering services and investment appraisals.
Davis Langdon & Seah Consultancy, a separate unit within DLS, consists of:
DLSC – Legal Support Unit DLSC – Building Services Unit DLSC – Cost Research Unit
Head: Ms Eugenie Lip Head: Mr Goh Chok Sin Head: Mr Ho Kong Mo
providing
Legal support services comprising front-end advisory work, advice on procurement strategy and contract forms, claims assessment,
expert witness, arbitration and litigation support, and all forms of dispute resolution processes.
Due diligence reports. Feasibility studies and early cost appraisals. Fire insurance valuations.
Project cost and contract audits. Capital allowances taxation assistance. Value management.
Research studies ranging from construction prospects and cost trends to procurement strategy, practice and contract
administration issues, life-cycle costing, sustainable construction and total building performance for the industry.
Contact Information
Ms Eugenie Lip, Head of Research and Consultancy
Davis Langdon & Seah Consultancy 1 Magazine Road #05-01 Central Mall Singapore 059567
Tel: (65) 6222 3888 Fax: (65) 6536 7132
Email: dlssp3@dls.com.sg Website: www.davislangdon.com

…@DLS Consultancy provides a synopsis of topical legal cases and professional practice issues in the construction industry and is intended for
information purposes only. While DLS Consultancy endeavours to ensure the accuracy and completeness of the information sheet, specific
professional legal advice should be obtained and no reliance should be placed on any part of its contents. All rights reserved. Copying in any form
or by any means (electronic, photocopying or otherwise) is strictly prohibited without the written permission of DLS Consultancy.
Printed by Kairos Design

Copyright  Volume 4 Issue 1 – April 2004