In this article, we consider whether target cost contracts can help KSA with its ambitious plans to deliver its infrastructure ahead of 2030? 

For those less familiar with the concept of target cost contracts, in very simple terms, a target cost contract operates so the anticipated cost to complete the works is set at the time the parties enter into the contract. The contractor is paid his actual costs to execute the works until such time as the pain/gain share is calculated at completion of the project. The contractor is typically entitled to recover his actual costs for his staff and labour resources and his actual costs for plant, materials, equipment, preliminaries and other pre-defined costs (utility costs, licence costs, import costs to name a few) and a fee (to cover the contractor's profit). This will be subject to any of these actual costs being treated as disallowed cost. An example of this is where the contractor has incurred actual costs in consequence of its own breaches of contract. 

If the actual costs are less than the target cost, then any saving will be split between the parties in accordance with the pre-determined gain share stated in the contract. If the actual costs exceed the target cost, then the difference will also be split between the parties in accordance with the pre-determined percentages in the contract. There is typically a "pinch" point where the employer wishes to limit its total exposure for substantial overspends on a project. These are typically known as "guaranteed maximum price" contracts and, in this case, the contractor carries the risk of the outturn costs greatly exceeding the target cost, unless the parties agree otherwise.    

Target cost contracts have been used to varying degrees of success in the UK. Most notable was the London 2012 Olympic Games, which is testament to how target cost contracts can successfully deliver major infrastructure within budget on time-critical programmes. There has always been much speculation on whether target cost contracts will gain popularity in the Middle East as they have in other parts of the world. 

The standard form target cost contracts are published by JCT, ICE, ICC, IChemE and NEC. Unfortunately, FIDIC which is predominately used and favoured by the industry in the Middle East does not publish a standard form of target cost contract. It was unfortunate that FIDIC did not seek to introduce a form of target cost contract when it issued its second editions in 2017. If an owner wanted to adopt this type of financial arrangement using a standard FIDIC form of contract, then bespoke amendments would need to be made to the general conditions of contract. 

Target cost contracts can be used very successfully, but one has to be mindful of the difficulties or problems which may arise if the contracts are unclear on the costs the contractor can recover and which party is responsible for significant overspends. 

As a reminder, in the UK judgment AMEC Group Limited v. Secretary of State for Defence [2013]¹ , the court had to consider whether the Secretary of State for Defence was liable to pay anything at all once the costs reached the maximum price plus £50 million and what precisely did it have to pay? 

In this case, the court decided that the Secretary of State for Defence was responsible for making further payments to the contractor once the costs maximum price plus £50 million figure had been reached, and the costs the contractor could recover had to be reasonably and properly incurred. 

This case highlights that the contract should be clear on what costs an employer is responsible for paying to avoid any nasty surprises. 

There are obvious benefits in using target cost contracts as they share the cost risk on complex infrastructure projects between the employer and the contractor. 

If the contract is clear in terms of the costs which are recoverable, and the target cost is realistically set, a target cost contract could be successfully used in KSA for its major infrastructure programmes ahead of 2030. 

This article is also available in Arabic, click here to download. 

1. AMEC Group Limited v. Secretary of State for Defence [2013] EWHC 110 (TTC)