Melbourne skyline. Credit: Michael Evans/Adobe Stock

Benjamin J Hicks

Melbourne

Introduction

A negative variation term permits an employer to omit works from a contract. The first part of this article sets out general principles for negative variations. This is followed by summaries of selected common law cases in the context of whether a negative variation may be used by an employer to execute works itself (or give works to others) and whether substantial (or essential) work may be removed from the scope of a contract.

A negative variation is a useful project management tool for omitting or abandoning works where an employer has technical or commercial doubts about the project or a shortage of funds. It may be more cost effective and have other benefits compared to a part termination or a termination for convenience. However, if the employer uses negative variations in contentious circumstances, unless clear wording in the contract says otherwise, the employer may be considered to have breached the contract and may be required to pay damages to the contractor.

General principles

What is a negative variation clause?

A contract for the execution of work provides the contractor with not only a duty to carry out the work, but a corresponding right to complete the work which it contracted to execute and realise profit. However, an employer may include a specific term in the contract to enable the contract administrator (acting on behalf of the employer) to instruct an omission of works from the contractor’s scope of works. This is called a negative variation.^[1]

To be effective, a negative variation clause must be specifically stated in a contract.^[2] Common law courts will not imply a negative variation clause into a contract and there is no separate common law right.^[3]

Why are there negative variations in contracts?

An employer’s reasons to include a negative variation clause may be for the option of postponing work until after the expected completion date, or to abandon work in circumstances where there are technical or commercial doubts about the project’s present viability or an unexpected shortage of funds. For example, an employer may postpone or abandon the project using a negative variation clause because of a market collapse even if the works are to be given to others later.

Alternatively, an employer may include a negative variation because, depending on the wording of the contract, it may be favourable when compared to a termination for convenience or part termination term. In particular, the negative variation may permit the employer to continue to employ the contractor under the same rights and obligations in the contract, whereas an alternative part termination or termination for convenience term, if exercised, may entail modified rights and obligations or require a new contract if the employer is to continue working with the contractor.^[4] An alternative termination for convenience or part termination term, if the employer were to seek to avoid damages, may be considered by a court as leonine and unenforceable as unconscionable.^[5]

When does a negative variation become a contentious issue?

The employer’s motive or reason in exercising the negative variation is irrelevant. The test is familiar and objective – what purpose did the contract envisage? ^[6]

A negative variation is unlawfully exercised under the contract if a common law court would not accept when reading the contract as a whole that the negative variation is wide enough to permit the changes made,^[7] or considers it an unreasonable exercise of the right,^[8] and no term displaces the contractor’s right to have the opportunity to complete all the works which requires very clear words to confer.^[9]

A negative variation will become a contentious issue where the contract administrator, in exercising the negative variation, will: take out a substantial amount of the works or works essential to completing the project from the contractor’s scope; and/or perform the works itself or give the works to others (including a provision sum item).

Unless clear words exist in the contract to permit the employer to do so, an employer will generally have breached the contract if its contract administrator uses a negative variation on the employer’s behalf in these two contentious situations, and, in substantial breaches, the employer will have been deemed to have engaged in repudiatory conduct, both permitting the contractor to recover damages (loss of profit etc).

Can risk allocation vary a negative variation?

Risk allocation for negative variations differs from contract-to-contract and may vary rights and obligations of parties at common law.

Ordinarily, building contracts confer discretion to the contract administrator (acting for the employer) to instruct the omission of works to the contractor in a negative variation. The JCT Design and Build, the MCC-1 (2021 edition), and AS4000 or AS4902 are such examples.^[10]

Risk allocation in contracts is becoming increasingly complicated and modern standard forms are beginning to address the two contentious issues specifically in the negative variation clause to vary the ordinary rights and obligations conferred to parties for the contentious issues at common law.

In FIDIC’s 1999 Red Book, the Engineer is given discretion to direct the omission of works but is specifically excluded from doing so if the work is to be ‘carried out by others’.^[11] The 2017 edition of the Red Book then goes further, additionally conferring on the contractor ‘profit and other losses and damages suffered (or to be suffered) by the Contractor as a result of the omission’.^[12]

NEC3 engineering and construction contract 2013 edition provides an alternative approach permitting works to be allocated by the project manager to others without incurring damages payable to the contractor, provided the omission is limited to a capped percentage of the works:

‘The Project Manager may also give an instruction to omit (a) any Provisional Sum and/or (b) any other work (provided the total value of all such work omitted under all instructions issued by the Project Manager shall not exceed 5% of the total of the Prices in the aggregate), even if it is intended that such work will be executed by Others. The Contractor has no claim for loss of revenue, loss of opportunity, loss of any contract, loss of profit or for any indirect loss or damage against the Employer in relation thereto.’^[13]

Example cases of negative variations for contentious issues

The cases summarised below are grouped as follows, based on the contentious use of the negative variation: (1) cases where the employer takes out a substantial amount of works; (2) cases where the employer has performed works essential to completing the project; and (3) cases where the employer has works performed by others.

These cases provide examples of the principles outlined above, demonstrating that – for more than a century – in the absence of clear wording in the contract, if the contract administrator uses a negative variation on the employer’s behalf in these contentious situations, the employer will generally have breached the contract and, in substantial breaches, will have engaged in repudiatory conduct, both permitting the contractor to recover damages (loss of profit etc).

Employer takes out a substantial amount of the works from the Contractor’s scope

Summarised below are cases where the employer had descoped a substantial amount of works and the employer was required to pay damages. These cases suggest that it depends on the facts of the case how a ‘substantial amount’ will be determined.

Gallagher v Hirsch [1899]^[14]

The employer engaged the contractor to carry out excavation and masonry work and to construct walls of a new building in New York. Before the builder fully completed excavation, it was discovered that it would be necessary to make additional excavations. The employer gave the additional work to others who performed this work as well as work originally included under the contractor’s contract. The negative variation term in the contract was:

‘should the owner at any time during the progress of the said building request any alteration, deviation, additions or omissions from the said contract he shall be at liberty to do so, and the same shall in no way affect or make void the contract, but will be added or deducted from the amount of the contract, as the case may be, by a fair and reasonable valuation’.^[15]

The trial court instructed the jury that the employer had no right to take away any part of the contractor’s contract and give it to another without the contractor’s consent. On appeal, the court agreed the negative variation did not permit the employer to omit works from the contractor and give them to others:

‘The word “omission” did not mean omitted from the plaintiff’s contract, but omitted from the work; and clearly could not be construed to have allowed the defendant to take two-thirds of the work from the plaintiff and then compel him to perform the rest.’^[16]

Stratfield Saye Estate Trustees v AHL Construction Ltd [2004]^[17]

The employer, (Stratfield Saye Estate Trustees), owned a derelict property in Hampshire, England and employed the builder, AHL, to undertake the first phase of works to make the property ‘wind and weather tight’.^[18] The employer later cancelled the project and instructed the builder to cease works except to leave the site in a suitable state.^[19]

Mr Justice Jackson held while ‘[the employer] was fully entitled to give instructions which would vary the details set out on the drawings or the works described in the site minutes’,^[20] this entitlement had a clear limit:

‘Phase 1 was understood by everyone to mean works which would convert Heckfield Wood House from a derelict property into a building which was wind and weathertight. The employer, acting through Mr Glover had no power to issue omission instructions which would detract from or change this fundamental characteristic of the works […]’^[21]

Employer takes out works essential to completing the project from the Contractor’s scope

Summarised below are cases where works essential to the project have been descoped and the employer was required to pay damages. Stratfield Saye Estate above may also fall in this category. This situation is distinguishable from cases where a substantial amount of work is descoped because the court’s consideration was not of the volume of work removed, but the type of work removed, whether it is ‘important’ or ‘fundamental characteristic’.

Ipson Renovation Ltd v The Incorporated Owners of Connie Towers [2016]^[22]

A contractor, Ipson Renovation, signed a contract with the employer, Incorporated Owners, for repair and maintenance works to be carried out in Hong Kong. At a general meeting, the employer resolved to cancel works relating to replacement drains serving the public toilets, water supply facilities, public ventilation windows, steel works, wood works and a provisional item for renovation of the exterior wall. Later in a notice to commence works, the consultant of the employer purported to exclude these works and reduce the contract sum by HK$4,292,700 from HK$37.07m.^[23] The employer relied on clause 4.7 of the contract to omit the works:

‘4.7.1. The Consultant may according to actual Project implementation and as the Employer requests issue an instruction for the variation of the Project.

[…]

4.7.2 “Variation of the Project” means any one or more of the following situations:

(b) addition, omission or alteration of work items required to complete the project

4.7.3 On the basis of any instruction for the variation of the Project, the Contractor has the duty to apply in writing to the Project Consultant for the value of any variation of the Project.

[…]

4.7.7 The value of all variations to the Project is only to be effective upon the Employer’s written approval and acknowledgement, and the Contract price of the Project shall be adjusted accordingly’^[24]

Mimmie Chan J considered clause 4.7 envisaged possible changes to be made to the project, which will occasion deductions to be made to items of the works.^[25] However, clause 4.7 was not wide enough to authorise the consultant to issue variation instructions to omit the works (other than the provisional sum item) ‘which concern important aspects of the Works forming part of the project’.^[26]

Employer gives the works to others

Summarised below are cases where the employer has descoped works from the contractor and given such works to others, requiring the employer to pay damages. Gallagher also falls in this category. Noteworthy is that a comparison of Carr v J A Berriman and Van Oord exemplifies how courts consider a negative variation clause that relies on common law compared to a clause which expressly addresses the common law.

Carr v J A Berriman [1953]^[27]

The employer engaged a contractor to erect a factory on his land in Australia. The contract contained a negative variation, where the architect could:

‘in his absolute discretion and from time to time issue further […] written directions […] in regard to: (a) the variation or modification of the design, quality or quantity of the Works or the addition or omission or substitution of any work’.

There was also a term in the contract that all steel was to be supplied by the employer to the contractor’s yard where the contractor was entitled to fabricate the steel.

After entering into the contract, the employer notified the contractor that the structural steel component was going to be supplied and fabricated by another firm and asked for confirmation of the allowance of fabrication to be a deduction from the contract.

Fulligar J (with Kitto J agreeing) judged the negative variation did not entitle the contractor to give the works to others:

‘[the terms] do not, in my opinion, authorise him [the employer] to say that particular items so included shall be carried out not by the builder with whom the contract is made but by some other builder or contractor […] a power in the architect to hand over at will any part of the contract to another contractor would be a most unreasonable power, which very clear words would be required to confer’.^[28]

Commissioner for Main Roads v Reed and Stuart [1974]^[29]

A dispute arose between a contractor and employer over the quantity of the topsoil required to form the final layer of material on embankments and elsewhere on site of the Warringah Expressway at the northern approach to Sydney Harbour Bridge. 49,700 cubic yards was estimated. However, the actual volume required was more than 60,000 cubic yards, whereas only 25,000 cubic yards could be obtained from the site.^[30] Clause B3.03(4) of the contract relevantly read:

‘If sufficient topsoil to meet the requirements of the Works cannot be obtained within the right-of-way, the Engineer may direct the Contractor in writing to obtain topsoil from other approved locations. The excavation and removal of topsoil from such locations shall be under the direction of the Engineer. Payment for such additional topsoil per ton will be made at the scheduled rate, and such price shall include the excavation or stripping of topsoil, loading and cartage of up to three (3) miles from source of supply to point of delivery and placement on the surface to be topsoiled.’^[31]

When the engineer discovered the required additional topsoil, instead of incurring the schedule rate of £3 per cubic yard, the engineer (on behalf of the employer) arranged for the topsoil on the site to be provided by a third party at cheaper rates. The contractor discovered the engineer’s actions and sought a judicial declaration that this constituted a breach of contract.^[32] The engineer acting for the employer sought to rely on the word ‘may’ in clause B3.03(4) being only an ‘option’ and a clause in the contract which permitted the omission from time-to-time of a portion of the works, to engage others.^[33]

Stephens J (with Gibbs and Mason JJ agreeing) disagreed with the engineer and held in favour of the contractor to issue the declaration, but varied the declaration to the relevant breach (failure of the engineer to give direction under cl B3.03(4)):

‘[…] By failing to give direction under the fourth paragraph of cl B3.03 rendered it impossible for the contractor to perform its contractual obligations, without such a direction it was confined to the use of on-site top soil of which there was insufficient. The resultant situation is not dissimilar to that which arose on the facts in Carr v JA Berriman […]’^[34]

Abbey Developments Ltd v PP Brickwork Ltd [2003]^[35]

A contractor, Abbey, engaged a subcontractor, PP Brickwork, to build houses on 69 plots at a housing estate in Kent, England. The builder notified the subcontractor by letter that it would be descoping the remaining plots and giving to another contractor, and charging the additional cost to the subcontractor. The negative variation read:

‘Whether […] instructions constitute a variation will be determined and valued by the Contract Surveyor, and, a Variation order will be issued detailing the changes and the value of such additions or deductions. The issue of a Variation order for additions or omissions to sections of the works will in no way vitiate the Sub-Contract, and Sub-contractors should take special note that no additional payments will be made except where a Variation Order has been issued, prior to the commencement of the works in question.’ (Condition 24 Variation)

His Honour opined the Condition 24 Variation does not confer a right to deprive the subcontractor of the opportunity to carry out the remaining work and for the contractor to give to others.

Van Oord UK Limited v Dragados UK Limited [2020]^[36]

A subcontractor, Van Oord, was engaged under a NEC3 subcontract by a contractor, Dragados to perform works on the Aberdeen Harbour Expansion Project, which included soft dredging works of which the volume was estimated at 2,150,000 cubic metres and to fill caissons.^[37] The contractor from time-to-time instructed omission of scope using a negative variation and transferred the work to other subcontractors.^[38] The negative variation clause at issue stated:

‘The Contractor may give instructions to the Subcontractor which changes the Subcontract Works information or a key date. The Contractor may in the event of a corresponding instruction being issued by the project manager under clause 14.3 of the Main Contract only, also give an instruction to omit (a) any provisional sum and/or (b) any other work, even if it is intended that such work will be executed by others. The Subcontractor has no claim for loss of revenue, loss of opportunity, loss of any contract, loss of profit or for any indirect loss or damage against the Contractor in relation thereto.’ ^[39]

Lord Tyre held the contractor was not entitled to omit works under the negative variation clause, since the project manager under the main contract had not issued a corresponding instruction to omit the works:

‘those clauses [14.3 and 11.2(19)] do not amount to a clear contractual entitlement to omit works and transfer them to another subcontractor, except in the circumstances in which omission of work is permitted by the second and third sentences of clause 14.3. It is not suggested by the defender that those circumstances subsisted at the time of any of the defender’s contractors instructions’.^[40]

Conclusion

A negative variation clause is an important project management tool intended to enable an employer to omit works when there is technical or commercial doubt over the project viability or a shortage of funds. Depending on the wording of the contract, the negative variation may help maintain the commercial relationship between parties and may be more cost effective for the employer when compared to a part termination or termination for convenience.

Common law has been clear for over a century that where the employer descopes a substantial amount of the works (or works essential to completing the project) and/or performs the works itself or gives the works to others, the contractor is generally entitled to damages (loss of profit) from the employer for losing its opportunity to carry out work and realise profit under the contract. An exception is in the case of a market collapse, where an employer may use a negative variation even if work is later given to others.

Judicial decisions have further suggested that while a negative variation may be validly exercised under a main contract, this may not be the same in a downstream or subordinate contract or arrangement. Furthermore, while provisional sum items are accepted as works that can be omitted as not essential, this may not extend to giving the provisional sum item to others.

Where a negative variation clause is silent on the above-described situations (such as the unamended JCT DB, MCC-1 (2021) or AS 4902 and 4000) there is a reliance on this common law position.

However, risk allocation is increasingly varying the common law position. The FIDIC Red Book and NEC3 are examples of where the contentious issues have been specifically addressed. As Lord Tyre opines in Van Oord for that NEC3 subcontract:

‘It is of significance that the parties have expressly provided in the contract for a particular situation in which the defender [builder] was entitled to give an instruction to omit work, that, in my opinion, raises at least a prima facie interference that in other circumstances the defender was not so entitled, in the absence of another equally clear provision empowering it to do so.’^[41]

Moving forward it is expected that parties will continue to adopt negative variation clauses in the contract, although there could be departure between the standard negative variation terms that rely on common law and the modern approaches to negative variation terms which specifically address the common law. The choice or applicability of negative variation in the future may depend on the market conditions, attitudes, and preferences of parties (including culture), and type of project (jurisdiction and sector based).

It is envisaged that the case law with respect to negative variation clauses may evolve in the future to consider different factual scenarios, these new modern contracts that specifically address negative variations, what the threshold percentage of ‘substantial amount’ of omitted works are and what works, other than provisional sum items, constitute essential (or ‘fundamental’ or ‘important’ Works).