CONTRACTS

Definitions

A. From a Legal Point of View

• A mutual agreement between two or more parties that something shall be done, an agreement enforceable at law

B. According to FIDIC

• Contract means the General Conditions, the Supplementary Conditions, the Specifications, the Drawings, the Bill of quantities, the Tender, the Letter of Acceptance, the Contract Agreement.

C. According to Method of Payment

• The agreement of how the owner will pay the contractor for work performed such as a lump-sum or cost-plus payment.

Why Use contract in construction?

• Describe scope of work

• Establish time frame

• Establish cost and payment provision

• Minimize disputes

• Improve economic return of investment

TYPES OF CONSTRUCTION CONTRACTS

Two broad categories:– Price Given in Advance Contracts (Priced-based contracts)– Cost Reimbursement Contracts (Cost-based contracts)

Factors Influencing the choice of the Type of Contract– The appropriateness for providing an adequate incentive

for efficient– performance by the contractor– The ability to introduce changes– The allocation of risks– The start and completion date of the project

Lump sum contracts

• involves a total fixed priced for all construction related activities.

• Can include incentives or benefits for early termination, or can also have penalties, called liquidated damages, for a late termination.

• Preferred when a clear scope and a defined schedule has been reviewed and agreed upon.

Lump Sum Contract( Advantages)

• Low risk on the owner, Higher risk to the contractor

• Cost at known at outset

• Contractor will assign best personnel

• Contractor selection is easy.

Lump SumContract(Disadvantages)

• Changes is difficult and Costly.

• Contractor is free to use the lowest cost of material, equipment, methods.

• The contractor carries much of the risks. The tendered price may include high risk contingency.

• Competent contractors may decide not to bid to avoid a high-risk rump sum contract.

Unit Price

• No total final price Quote Rates / Prices by units

• Re-negotiate for rates if the quantity or work considerably exceeds the initial target

• Payment to contractor is based on the measure.

• Unbalanced bids

• Higher risk to owner

• Ideal for work where quantities can not be accurately established before construction starts

Unit Price contract

• Require sufficient design definition to estimate quantities of units

• Contractors bid used on units of works

• Time & cost risk (shared)

– Owner : at risk for total quantities

– Contractor at risk for fixed unit price.

• Large quantities changes (>15-25%) can lead to increase or decrease of unit price.

Unit Price ( Advantages)

• Easy for contract selection.

• Early start is possible.

• Saves the heavy cost of preparing many bills of quantities by the contractors.

• Fair basis for competition.

• In comparing with lump-sum contract, changes in contract documents can be made easily by the owner.

• Lower risk for contractor.

Unit Price (Disadvantages)

• Final cost not known from the beginning (BOQ only is estimated)

• Staff needed to measure the finished quantities and report on the units not completed.

• Unit price sometime tend to draw unbalanced bid.

(for of Unit-Price Contracts, a balanced bid is one which each bid is priced to carry its share of the cost of the work and also its sham of the contractor‘s profit).

Contractors raise prices on certain items and make corresponding reductions of the prices on other items without changing the total amount of the bid)

Percentage Rate Contract

• Client draws up the schedule of items with quantities, rates, units and amount.

• The contractors are required to offer to carry out the work at par with the rates shown in the specific price schedule or percentage above or below the rates indicated

Advantages

• Comparative position of contractors is readily known

• No possibility for contractors to tamper with the rates in order to quote the lowest tender

• No possibility of an unbalanced tender

Disadvantages

• Contractors quote lowest tender without analyzing the actual rates, so thorough verification to be done by the client

• By negotiation, 2 or more contractors may quote same percentage at higher price

Labour contract

• Contractor need to quote rates for item work exclusive of materials which will be supplied by the Department free of cost

Advantages:

1. Materials stored by Govt. are utilized.

2. Difficulty in obtaining certain materials in open market are easily obtained

Disadvantages:

1. May be delay in obtaining materials, hence contractor need be in touch with client

2. Large storage area is required

3. Refund of surplus materials to the client without any damage

Material supply contract

• Contractors have to offer their rates for supply of required quantity of materials inclusive of local taxes, carriage and delivery charges to the specified stores within the time specified

Advantages:

• Payment will be paid promptly

• No need to worry due to loss of materials, breakage etc during transit

Disadvantages:

• Quality check has to be done constantly

• Contractors may negotiate and quote tender at higher prices

Piece work agreement

• Small part of work need to be done

• Rates can be quoted without any reference with the total quantity of work

• Can be terminated by both parties at any instance without any penalty

Advantages:

• Urgent small work can be carried without any tenders

• If a contractor leaves, another can take the work

Disadvantages:

• Only petty contractors are interested in this contract. Hence careful supervision is required

Cost Plus contracts

1. Actual cost plus a negotiated reimbursement to cover overheads and profit.

2. Different methods of reimbursement– cost+ percentage– Cost + fixed fee– Cost + fixed fee + profit-sharing clause.

3. Higher risk to owner4. Compromise : guaranteed maximum price (GMP)

reduces risk to owner while maintain advantage of cost plus contract

5. By using this type of contract the contractor can start work without a clearly defined project scope, since all costs will be reimbursed and a profit guaranteed.

Cost + Percent of Cost

• The contractor is reimbursed for all his costs with a fixed % age of costs over his services.

• Project/site overheads may be covered by the %age or computed as one of the costs.

Cost + Percent (Advantages)

• Construction can start before design is completed.

• If the contractor is efficient in the utilization of resources then the cost to the client should represent a fair price for the work undertaken.

Cost + Percent (Disadvantages )

• The project total cost is completely unknown before the project start.

• No incentive for the contractor to be efficient in his use of labors, materials or equipments.

• Minimum efficiency maximizes the profit.

Cost Plus Fixed Fee

• Most common form of negotiated contracts

• COST = expenses incurred by the contractor for the construction of the facility

– Includes: Labor, equipment, materials, and administrative costs

• FEE = compensation for expertise

– Includes: profit

Advantages

• Fee amount is fixed regardless of price fluctuation

• Provides incentive to complete the project quickly

Disadvantages

• Expensive materials and construction techniques may be used to expedite construction

Target contract

• Contractor will be paid on a cost plus percentage basis

• In addition, he receives a percentage plus or minus on his savings or excess over a prior estimate

Advantages

• He can use his skill and expertise to reduce the cost of work

Disadvantages

• Contractor may show higher cost of construction and gain more amount even cover his penalty

Guaranteed Maximum Price contract

• In a guaranteed maximum price (GMP) contract, the contractor estimates the cost just like in a lump sum bid, but profit is limited to a specified amount.

• In the event that actual costs are lower than the estimates, the owner keeps the savings.

• In the event costs are higher, the contractor pays the difference and profit is reduced.

Advantages

• GMP promotes pre-agreement of changes as it’s philosophy links neatly with a contractual requirement to pre-agree the cost and time implications of any potential changes.

• GMP provides greater control over spending as the contractor is bound to a maximum price. This alerts the team to any potentially expensive items of design development,

• GMP aligns the contractor with client and consultants encouraging team or with mutual trust and common goals.

• Less administration is required as changes are limited; there is quick settlement of the final account.

Disadvantages

• The client might pay too much as the contractor takes on greater risk and thus includes in the price an allowance for design development and risk. Often a competitive price is sacrificed in lieu of appointing a contractor early.

• Contractor's with design and build experience may have useful knowledge.

• There is no standard form of contract for GMP so there is a greater possibility of errors and misunderstandings of liabilities between the parties that may result in conflict

• Scope changes tend to cost more, it is accepted that scope changes to design and build are more likely to be more expensive than with a traditional contract, the same can also be said for GMP contracts.

TENDER

• Tender is a written offer submitted by the contractors to execute certain work at certain rates with terms and conditions

Tenders can be grouped into

1. Open or public tenders

2. Selected or limited tenders

3. Negotiated tender

Open tender

• Any contractor fulfilling all formalities to compete can enter

• Due to competition, it may have low cost

• Work may be given to unknown

• Result in delays, extra items etc

limited tender

• Only limited no: of contractors are called

• Competition in low scale

• Skilled work

• Successful completion of work

Negotiated tender

• Advance form of selective tender

• Contract is negotiated with 1 or mostly 2 contractors

Earnest money

• It is an assurance in the form cash or bank deposit to confirm his intention to take up work

• In case, he fails to complete the work, the money will be forfeited to the government

• Works upto 5 lakhs – 2.5%

• Above 5 lakhs – 2%

Security Deposit

• It is an amount deposited by contractor whose tender is accepted

• Has to pay the amount to the client, if work is not completed