Legally Bound

What are the limits to variations?

Jordan ... the difference between a variation and a new contract is easier to recognise than to define.

Variations (or change orders, if you prefer) are essential tools, to avoid the parties having to agree a new or amended contract every time the owner needs to change the scope of works.

Typically, a variation is defined as any change to the permanent works. Additional work or less work or different work, are treated as variations.

Are there any limits to the changes that can be instructed – either in the substance or the degree of those changes? In practice, this is almost always about degree and not substance. This question about limits arises mostly in connection with instructions to omit works, that is, to delete work items from the scope. This can be controversial, especially where the owner is seeking to omit a substantial amount of the scope or all of the remaining scope: effectively reversing the original award of the contract.

What about changes to the substance of the works? For instance, can you award a contract to build a sports stadium and issue a variation order to build a gas-fired power plant instead? With such an extreme example, of course, most people would answer: No. But where is the line? This is usually an academic question because we rarely see a real example of instructions like this, but a recent dispute provides an excellent illustration.

For once, the parties to the construction contract were not in dispute with each other. The owner (Cobalt Data Centre 2 and 3 LLP) was in dispute with the UK tax authority (HMRC) and the issue was eligibility for tax breaks offered to developers of commercial and industrial property, in the form of Enterprise Zone Allowances (EZAs). Eligibility for EZAs required that construction contracts for building on a site within an Enterprise Zone were entered into within 10 years of the legislation introducing the EZAs, with expenditure under that contract being made within a further 10 years.

The owner entered into a construction contract one day before expiry of that initial 10-year period, but they had not yet decided what to build, so the contract contained six individually-priced options for different types of building on three potential areas within the Enterprise Zone. The options included a manufacturing facility, other industrial use and an office park. The contract was made in order to obtain the benefit of the EZAs, known colloquially as a “Golden Contract”.

The contract provided for scope change, to include “the addition, omission or substitution of any work”. So, on the face of it, there were no limits on making scope changes.

The parties then entered into deeds of amendment to the contract, allowing the owner to give Notice to Proceed on more than one of the options. Then, the owner issued three “Change Orders”, all related to Option One (originally a facility for manufacturing semiconductors) instructing instead the design and construction of three data centres.

The owner claimed the benefit of EZAs but HMRC challenged eligibility on the basis that the variations were so radically different from the original contract (in any of its options) that the instruction amounted to a new contract entered into after the 10-year limit. The dispute went to court and eventually to the English Court of Appeal, which decided in favour of HMRC.

In dealing with the central question: (Was this purported variation truly a scope change within the original contract or is it a new contract?) the court followed existing case law in seeing it as a matter of degree: applying the facts of the purported variation to the terms of the contract. The judgment considered the existing case law and well-known textbooks on this question; and the recurring critical issue was whether a variation alters the essential character of the original agreement.

The court’s view is summarised by one judge:

‘Since the developer was requiring the contractor to carry out building work which was wholly outside the existing scope of the golden contract, for a consideration not mentioned in that contract, and on a part of the site not covered by the works option which it had already exercised, then if the contractor agreed to do the work for that price, in my judgment the correct analysis is that they made a fresh contractual bargain.’                  

So the difference between a variation and a new contract remains easier to recognise than to define, but this decision is in line with others, in which courts and arbitrators look at whether the scope change is a fundamental alteration of the original deal.

Interestingly, the court was not concerned by the fact that the original contract did not commit the owner to proceed with any of the six original options so, unless and until a Notice to Proceed was issued, there was no contractual obligation on the owner at all. The court still saw this as a contract capable of attracting the benefit of the EZAs. Perhaps if the owner had inserted 60 options, including data centres, they would have been OK! 


* Stuart Jordan is a partner in the Global Projects group of Baker Botts, a leading international law firm. Jordan’s practice focuses on the oil, gas, power, transport, petrochemical, nuclear and construction industries. He has extensive experience in the Middle East, Russia and the UK.