1 Chem E - Target Cost Contracts (The Burgundy Book) Page 1 of 3 Title: I.Chem - Target Cost Contracts (The Burgundy Book) Brief Description: ‘A discussion of the contents of the target cost contract issued by the Institution of Chemical Engineers. Applicable Law: England and Wales Last Reviewed: January 2005 Submitted: February 2004 The Institution of Chemical Engineers’ (| Chem E) Forms of Contract are intended primarily for process plant works, but are adaptable for use elsewhere. The "Burgundy Book" was published in November 2003 in response to the industry's demand for a target cost form as a stand-alone contract. This avoids the need for users to draft amendments to existing forms in order to incorporate target cost elements into their ‘contract AA target cost contract is one where the contractor is reimbursed his actual costs subject to a formula which allows the contractor to share in savings made ("gain share") or to contribute towards additional costs incurred ("pain share"). The aim of the contract is to provide the parties with clear business objectives in order to deliver the works to an optimum level of quality in the most economic way possible. However, an evaluation of the technical and commercial risks of the project is needed in advance so as to devise target cost provisions that reflect those risks and reward the contractor for adding value, Overall, the target cost approach is seen as providing a good vehicle for making significant savings (despite the increased Tesource necessary to manage day-to-day cost monitoring), and for fiexibilty as the target cost can be agreed during the contract period and any later variations can be agreed/costed with more ease. ‘Schedule 18 of the contract defines the actual cost broken down into its constituent elements, e.g. head office and site costs. This is the contractor's actual expenditure and sums due to him. It is a vehicle for assessing the pain or gain share as shown below. ‘Schedule 19 of the | Chem E contract deais with the target cost, and should be divided into two parts, being first the target cost and its make-up, and, secondly, payment. The make-up of the initial target cost, or the procedure for agreeing it, should be recorded in the first part. The initial target cost should be defined in as much detail as possible, as this makes it easier to agree any necessary adjustments to the target cost during the period of the contract. The parties will therefore have to consider the cost of the provision of each element of the plant and the undertaking of all other activities which together form the works. However, the inital target cost should not be set until after any site investigation work has been carried out but before construction work on site has started. Before then, the parties may proceed on a cost- reimbursable basis, for example as to initial works or design development. Contractor's proposals for variations cannot add to the target cost but if savings result the benefit can (at least in part) be shared Arisk register may be developed so as to include allowances in the target cost for the cost of each risk. With regard to the payment section, the potential "gain share" and/or “pain share" mechanisms are to be set out here. It is common for a management fee to be identified (to cover both the contractor's head office ‘overheads and his basic provision for profi), with some parties choosing to establish a separate fee for all design work, or perhaps for all design work undertaken prior to agreeing the initial target cost. The latter fees may be outside the actual cost and hence not part of the target calculation. A fixed fee is not suggested as it is likely to reduce creativity. A bonus for design (e.g. if shown to result in cost savings) andfor timely completion may be appropriate. One must additionally set out with clarity how any contingencies and prime cost sums (if such sums are to be included in the contract) are to be incorporated into the payment mechanisms, Various mechanisms are also possible with respect to the comparison of actual cost and target cost: http:/www.elexica.com/seripts/checklink.asp?area=Items&resource=d7c176Scl fga.htm 29/04/20051 Chem E - Target Cost Contracts (The Burgundy Book) Page 2 of 3 a. a fixed share of the gain share (typically 50:50), with the pain share starting off on a similar basis but then the contractor's responsibilty to fund the overspend becoming increasingly greater, b. a straight-line share of gain and pain on an equal footing, with or without caps on the contractor's exposure to pain and an equal and compensating cap on the contractor's share of the gain; ©. a share of pain and gain but with 2 degree of pain beyond which all expenditure is for the contractor to bear (such a threshold should be expressed as a percentage of the target cost); however, this may be undesirable at the stage of testing plant and hence a limitation to the value of the management fee may be desirable; 4d. a neutral band in the middle (e.g. anything +2 per cent or -2 per cent of the target cost is deemed to be on target), with anything outside the neutral band being calculated on the single value target cost. ‘As to payment, clause 39 applies. Payment is by monthly instalments. The contractor presents his estimates of expenditure in the next month and his actual expenditure in the preceding month. The project manager certifies the sum which, in his opinion, is properly payable under the contract. Where actual cost is less than target cost an additional amount may be payable at the final statement. If, in the project ‘manager's opinion, the total actual cost is expected to be greater than the final target cost, the project manager may adjust the certificate so that the final payment will show in the remaining amount due for Payment to and not from the contractor. Overpayment can be recovered by a negative certificate. The contract price will be, therefore, the appropriate proportion of actual cost plus the management and design {fees (as appropriate) and any bonus as stated in the contract Until recently there was only one standard form for target cost contracts, namely the NEC/ECC options C and D. This is now joined by | Chem E's form, and ICE are expected to publish their own version shortly. Not surprisingly, | Chem E and NEC's approach is broadly similar in providing a framework for the use of target cost contracts and leaving it to the parties to devise their gain and pain mechanism, although offering advice in guidance notes. However, there are some differences between NEC's approach and | Chem E'S approach, as follows’- = | Chem E have only one form whereas NEC/ECC have two versions where the target price is based either on a lump sum spiit into activities or on a bill of quantities. = Under NEC the contractor is paid his actual cost as he proceeds and may therefore be temporarily overpaid, with the appropriate adjustments being made after completion. Under | Chem E the project’ manager may reduce payments where actual cost is expected by the project manager to exceed target cost so that, at completion, the contractor will not owe Money to the employer. = NEC specify items to be regarded as disallowed cost whereas | Chem E provide a brief definition of actual cost, whilst leaving the elements disallowed to be largely defined in a schedule. In particular, NEC/ECC disallow costs relating to the correction of defects caused by not complying with the requirements in the Works Information. | Chem E disallow costs of defects where the sub-contractor makes them good without further cost to the contractor or where they are due to the failure of the contractor to exercise the requisite degree of skill and care. There is a limit on the variations which may be ordered within | Chem E whereby the contractor may object to variations that (combined with those previously ordered) increase the target cost by more than 26 per cent, require him to exercise skills beyond his usual range, or to use resources beyond his current capacity and which are unavailable to him, There is no such restriction in NEC/ECC. http:/hvww.elexica.com/scripts/checklink.asp?area=Items&resource=d7c1765clfga.htm 29/04/2005I Chem E - Target Cost Contracts (The Burgundy Book) Page 3 of 3 For more information please contact Robert Bryan or your usual contact at Simmons & Simmons. This document is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document. 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