In today's climate of tight margins and scarcity of construction services due to commitments elsewhere, clients are increasingly looking for ways to attract contractors to tender and encourage them to complete on budget.
Many seek to achieve this through a "partnering" approach whereby the parties agree to work in a collaborative manner to carry out the project. Target Cost Contracts (TCC) are often used to support the sharing of financial risks and rewards.
Under a TCC, a target cost for the project is agreed at the outset, which is fixed subject to allowable events that result in a change to work or programme. The contractor is paid his actual out-turn cost of carrying out the work, together with a percentage fee during the project.
On completion of the work, the actual cost is measured against the target cost. If the actual cost exceeds the target cost, the contractor and employer each bear an agreed element of that cost overrun. If the actual cost is lower than the target cost, the contractor shares the saving with the employer. The contract will set out the mechanism for agreeing the share of the overrun or saving for each party.
Critical to the operation of a TCC is a realistic target cost, a well thought out pain/gain formula and effective project management. If insufficient time or energy is put into any or all of these elements, problems can arise which may negate the benefits of a TCC.
A properly considered TCC can bring many advantages to a project, including improved performance and effective risk management. However, its success will ultimately rest with the attitude of the parties to the contract and those administering it, to ensure that the costs are accurately recorded and audited and that the pain/gain mechanism is properly understood and managed.
Juliet Haldane is a partner specialising in Construction and Special Projects at UK law firm Shepherd and Wedderburn.