Pros, Cons and thoughts
What is a provisional sum ?
A provisional sum is a monetary amount which is ‘allowed’/included within a tender offer or contract to provide for something which is not yet known at the time.
Once the works are confirmed, the works are valued and ‘swapped’ with the provisional sum to arrive at the correct contract value.
For example, imagine a house builder tendering for a contract to build a home for its customer. In this scenario the customer does not know how it would prefer its garden to be designed, and may want the ability to change its mind.
Rather than enter into a contract for the wrong amount knowing the garden plans are not complete, the parties can ‘allow a provisional sum’ which acts as a budget for the works. This way the customer may remain confident that the contract will remain within the budget.
This is particularly useful when the contract value is used to satisfy the customers financing arrangements, for example as part of the bank loan process.
Other reasons for provisional sums include:
- Limited tendering time
- Work known but material product or equipment selection not yet made
- Programme unknown
An unknown programme / working schedule may require a provisional sum as more often than not, time is money.
Construction projects have legal requirements such as Health and Safety. These requirements typically require management, which in turn usually incurs a salary and/or wage which is calculated on the basis of time.
Similarly, onsite and offsite overheads typically include further time based costs such as insurances, rent and equipment hire on an ongoing basis.
Provisional sums v PC sums
Prime Cost sums (PC Sums) are slightly different to provisional sums. There is quite a bit of confusion within the NZ construction industry pertaining to these definitions.
Part of the confusion is that a significant proportion of the New Zealand construction sector uses short hand i.e. P Sums, to describe allowances within tender offers and contracts. This is not good enough because it does little to describe which type of sum has been agreed by the parties.
Prime cost sums are allowances for the ‘supply’ of something only, i.e. the amount agreed for installation/building/or to provide a service is included in the contract elsewhere. A typical example of a PC sum is a house builder who doesn’t know what furniture or carpets etc the home owner wants.
In this scenario the home owner may shop around and then tell the builder their budget for what they may eventually choose. This amount is included in the contract as a PC sum.
The reason it may not be a provisional sum is because the work to install the carpet is the same irrespective of what carpet is chosen (this may not actually be the case of course but it suits the example).
The labour to install the carpet can be fixed and put to one side as agreed. This affords the least amount of commercial ambiguity while maintaining flexibility of choice.
A typical common example of provisional sums in the commercial space is ‘services builders works’. There are many projects which begin prior to completion of the full design.
Inherently this means that the services are often varied (in location, scope or equipment) as the project design proceeds.
It may be difficult to be able to calculate a cost for builders works to support services without actually knowing the services design. This is an example of when a provisional sum may be used.
How do provisional sums work ?
The quick answer is that it depends on the contract. There is no standard method of measurement which deals succinctly with provisional sums, particularly standards pertaining to valuation and risk. Sparse requirements for description are found in NZS 4202:1995 & ANZSMM 2018 although these standard methods of measurement are signed up to and aren’t compulsory standards.
Typically provisional sum valuations are calculated the same as other variations. Essentially that is what performance of the provisional sum works is, a variation from no works to introduction of the works.
Parties may choose to agree rates which will apply to provisional sums specifically as they may occur.
A common dispute
Whether the provisional sum includes the costs to manage the provisional sum works or not often arises as a common dispute. The contract should set out that provisional sum valuations must include for the management of the provisional sum works’ unless the opposite is agreed.
The problem with the alternative is that the parties don’t know how long the work would take, and it follows they have little idea of the time based costs associated with the works which will take place.
It takes significantly more to manage 1000 small changes than 1 change. By retaining the management fees payable from within the provisional sum, the risk of under pricing/allowing for the works is somewhat mitigated.
Similar concessions should be made with extensions of time for the same reasons.
What if the provisional sum is exceeded?
More commonly the risk of exceeding the provisional sum lies with the payer. Usually the variations which form part of the provisional sum are administered independently and may not be initially identified as part of the provisional sum when directed.
However, the parties have freedom to contract.
The ability to assign risk as parties sees fit can lead to guaranteed maximum price type terms and commitment to pricing risk.
Provisional sums are a useful tool for spend reconciliation and contract security, but parties must have confidence in the adequacy of the sum to gain the full benefit as an administrative tool.
There appear to be reoccurring issues with interpretation and risk allocation throughout the industry which would benefit from a widely known standard of application.
If you have a query regarding your own provisional sum terms, or want to discuss a dispute then don’t hesitate to contact us.