In Short
- A negative variation is where part of the contracted work is removed, reducing the contract value.
- Principals can only order negative variations if the contract clearly allows it.
- Removing too much work, or omitting work to give it to another contractor, may amount to a breach or repudiation of the contract.
Tips for Businesses
Before issuing or accepting a negative variation, review the variation clause carefully to confirm what it allows. Avoid omitting work simply to engage another contractor unless the contract expressly permits this. Record variations in writing, agree on price and timing impacts early, and assess whether the change risks going beyond the contract’s permitted scope.
Summary
This article explains the legal limits on negative variations in construction contracts for businesses operating in Australia. LegalVision, a commercial law firm specialising in advising clients on construction and infrastructure matters, outlines when negative variations are permitted and when they may expose parties to termination or damages claims.
Table of Contents
- What are Negative Variations?
- Understanding When and Why Negative Variations Occur
- Omitting a Portion of Works to Engage a Third-Party Contractor
- Can You Omit All (Or Almost All) of the Works?
- Impact on Different Contract Structures
- Financial Complexity Beyond Simple Cost Reduction
- Other Limitations
- Practical Implications
- Key Takeaways
- Frequently Asked Questions
Construction contracts include a lengthy and detailed scope of work. Generally, following the signing of the agreement, there is no right to vary the scope of this work. However, the contract itself may give the principal the ability to order a variation of the scope of work. Sometimes, a variation removes part of the scope of work. As a result, this reduces how much work will be completed. We refer to this process as a negative variation. This article will first explain negative variations. Then it will discuss the limits a principal must abide by when ordering a negative variation on a construction contract.
What are Negative Variations?
If something falls outside the contract’s scope of work, the parties must order a contract variation. Construction contracts generally include a clause allowing the principal to order such a variation to the scope of works.
A negative variation occurs when the principal seeks to reduce the scope of the work. Naturally, this reduces the value of the contract. Negative variations generally occur in three circumstances:
- the works are no longer required, e.g. in the case of a design change;
- you are engaging a different contractor for a portion of the work; or
- the project (or part of a project) is no longer continuing.
Whether the scope of work can be negatively varied will depend on the contract itself. A variation that substantially changes the scope of work may amount to a repudiation of the contract, unless the contract clearly gives a right to make that change. This means the principal has demonstrated they are unwilling to perform their obligations under the contract. In doing so, they are allowing the other party to terminate the contract and seek damages.
Understanding When and Why Negative Variations Occur
Negative variations arise when a party reduces the scope of work under a contract, leading to a corresponding decrease in the contract sum. While they may deliver cost reductions, changes in project circumstances usually drive negative variations rather than deliberate cost-saving strategies.
Common causes include design amendments during construction, regulatory or authority requirements that require changes to the scope, and budgetary constraints that lead parties to omit or reduce elements of the works. Material substitutions may also give rise to negative variations where parties replace originally specified materials with lower-cost alternatives.
Negative variations can also result from inaccuracies or assumptions in early project estimates, with scope reductions occurring as design development progresses and more detailed information becomes available. Although such variations may assist in managing project costs, they can introduce contractual, programming and relationship risks if not clearly documented, properly valued and managed in accordance with the contract.
Continue reading this article below the formOmitting a Portion of Works to Engage a Third-Party Contractor
The High Court in Carr v JA Berriman Pty Ltd (1953) decided that reducing the scope of works in a contract to engage a third party to complete the works is not a valid variation unless the contract contains an explicit power to do so.
Entering into a contract gives a contractor an obligation to carry out the work, along with a corresponding right to complete the work they agreed to perform. Contractors often divert resources from elsewhere with the expectation that they will recover those costs through the contracted work. They make these investment decisions based on the scope they agreed to complete. If the value of the contracted work changes significantly, the contractor may incur losses on investments already made.
Can You Omit All (Or Almost All) of the Works?
The contract may give the principal an express power to order a negative variation to the scope of the contract. Even so, there are implied limitations on how much work one can omit. The court in Chadmax Plastics Pty Ltd v Hansen and Yuncken (SA) Pty Ltd (1984) decided that you can not cancel a contract using a variation clause.
In this case, the principal contractor engaged a subcontractor to apply a Wallflex finish on the walls of a building they were constructing. The principal contractor later changed their mind about this finish. As a result, they issued a negative variation. However, this removed approximately 98 per cent of the works in the subcontract.
The court said that a principal could not omit such a large portion of the work. Such an omission effectively terminates the contract, as there is no longer any work to be completed. You can include variation provisions to change project requirements, not cancel it altogether.
Impact on Different Contract Structures
In lump sum contracts, negative variations can present particular challenges where scope reductions occur after the contractor has committed to materials, plant or subcontractor arrangements. Although the contract sum adjusts to reflect the reduced scope, contractors may still incur unrecoverable costs for resources they have already procured or engaged. This often leads to disputes about how parties should value omissions and whether they should allow for committed costs, loss of economies of scale, or disruption to planned sequencing.
In cost-plus contracts, parties can usually administer negative variations more straightforwardly because the principal reimburses contractors for the actual costs they incur. However, where contractor remuneration includes a percentage-based management or overhead fee, reductions in scope will proportionately reduce the contractor’s margin. This can lead contractors to resist significant scope reductions unless the contract includes minimum fee or guaranteed margin protections.
Unit price contracts typically provide clearer mechanisms for valuing negative variations, with reductions assessed by reference to omitted or reduced measurable quantities at agreed rates. However, substantial scope reductions may still affect the contractor’s ability to recover fixed overheads and preliminaries, underscoring the importance of contractual provisions addressing minimum payments, standing costs or rate re-balancing.
Financial Complexity Beyond Simple Cost Reduction
While parties often view negative variations as delivering straightforward cost savings, their financial consequences can be more complex in practice. Reductions in scope may disrupt cash flow for both parties, particularly where a party has already ordered materials or engaged subcontractors in reliance on the original scope of works.
Supplier and subcontractor pricing frequently relies on volume-based discounts, which parties may lose when quantities are reduced. This can increase the unit cost of the remaining works and erode the anticipated savings. In addition, the removal of certain elements can create inefficiencies in construction sequencing or necessitate future remedial or additional works, converting short-term savings into longer-term costs if not carefully assessed.
Other Limitations
A variation must be within the general scope of the contract and cannot include changes beyond the original scope of work. How you can order a variation will be set out in the contract. The principal contractor must issue the variation in the manner set out in the contract. Usually, you should issue a variation via written notice and should note any necessary adjustments to the contract price and duration.
Once practical completion of the contract has eventuated, the power to vary the scope of works may no longer be available, unless expressly stated in the contract. Practical completion occurs when the works are substantially complete. Any incomplete work is of a minor nature that does not affect the ability of the principal to occupy and use the structure.
Practical Implications
A negative variation to the scope of work will usually result in a reduction of the contract sum. Ensure you discuss any changes to the contract sum before completing work on the variations to avoid a dispute later on.
A negative variation may also result in a change in the timeline for completion. This is because the principal may require the reduced scope of work to be completed more quickly than initially planned. If you issue variations in writing it makes it easier to track changed deadlines and agree on appropriate and achievable timeframes.
If you work in the building and construction industry, understanding how key clauses in your contract allocate risk is critical to protecting your business. This guide outlines the top 10 risk clauses commonly found in construction contracts.
Key Takeaways
A negative variation is where part of the scope of work under a contract is removed or deleted. Contracts need to contain clear and express wording to allow for negative variations. If you negatively vary a contract beyond the limits discussed above, it may result in a right for the other side to terminate the contract and seek damages for breach.
LegalVision provides ongoing legal support for construction businesses through our fixed-fee legal membership. Our experienced lawyers help businesses in the construction industry manage contracts, employment law, disputes, intellectual property and more, with unlimited access to specialist lawyers for a fixed monthly fee. To learn more about LegalVision’s legal membership, call 1300 544 755 or visit our membership page.
Frequently Asked Questions
A negative variation occurs when the principal reduces the scope of work under a construction contract. This typically lowers the contract sum. It can happen due to design changes, engaging a different contractor, or project adjustments. The contract must expressly allow such reductions for them to be valid.
A principal cannot use a negative variation to cancel the contract. Courts have ruled that removing nearly all the work effectively terminates the agreement. Negative variations must stay within the contract’s scope, adjusting the project requirements without eliminating the contractor’s essential obligations or rights.
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