4.1. Contract Administration

4.1.1.      Contract

A construction contract is a legally binding agreement between two parties on the details and cost of a construction project. This type of contract covers very expensive, complex projects and simple renovations. There are two types of clients that use construction contracts: residential and commercial. Each client has different requirements that determine what is included in the contract.

A residential construction contract includes three basic elements: project scope, schedule of work and payment details. The project scope is a statement of exactly what construction work is included in the contract. Both parties must agree that this section provides an exact representation of the required work.

The payment details section includes the total project cost and payment dates. All construction projects are paid on a percentage of completion basis. A deposit of no more than five percent of the total costs is provided at the start of the project. The next payment is made when the predefined section of work is completed.

4.1.2.      Contract Management

Contract Management could be defined as a multi-stage process that goes on through the entire duration of the contract and ensures that the parties meet their contractual obligations in order to deliver the specific objectives provided in the contract.

Therefore, the ultimate objectives of contract management are:

  • Effectiveness

The first and foremost condition of successful contract management is getting the job done. This translates in the fact that the ultimate scope/objective of the contract is accomplished:

  • Goods are delivered/installed;
  • Services are performed;
  • Civil works are completed.
  • Efficiency

Just getting the job done is not enough for a successful contract management. We should also be concerned about how the job is getting done. The aim should always be to get the job done in the best possible way. This means that the scope/objective of the contract is accomplished within the agreed:

  • Costs (budget);
  • Time (duration);
  • Quality (functional parameters).

Note: Achieving efficiency should not be mistaken for an unrealistic chase for cost savings, or unreasonable pressure to squeeze more output from the contractors for less money or less time. These practices frequently backfire and may result in more time and resources being misdirected towards a false objective.

4.1.3.      Management of Civil Works Contract

The civil works contracts are among the most complex contracts generally throughout the business world. They are therefore the most challenging in terms of contract management.

To begin with, there is a very large variety of types of civil works with various degrees of complexity and risks and even more various types of expertise required for their management.

Type of civil works – large infrastructure projects (highways, bridges, roads, irrigation systems, dams etc.), smaller scale municipal infrastructure projects (rehabilitation of buildings, roads, sewage, water or power utilities), environmental rehabilitation projects (earthworks, planting, seeding, water management etc.).

4.1.4. Construction Contracts

The legally essential elements of a construction contract include an offer, an acceptance, and a consideration (payment for services to be provided). The offer is normally a bid or proposal submitted by a contractor to build a certain facility according to the plans, specifications, and conditions set forth by the owner. Acceptance takes the form of a notice of award. Consideration usually takes the form of cash payment, but it may legally be anything of value.

Contracts may be classified in several ways. Principal methods of classification are:

1. method of award is the method used during a procurement in order to evaluate a proposal.

  • formally advertised contracts usually for government projects follows RA 9184 known as the Government Procurement Reform Act
  • negotiated contracts as the name implies, is one that is negotiated between an owner and a construction firm.

While government procurement regulations establish formally advertised competitive bidding as the normal process, negotiated contracts are permitted under special circumstances. Private owners may, of course, award a contract in whatever manner they choose.

2. method of pricingThere are two types of contract by method of pricing. Each of these types has a number of variations. The choice of which construction contract to use oftentimes comes down to the owner’s risk tolerance.

fixed-price contracts

  • firm fixed-price contracts – provide for a price that is not subject to any adjustment on the basis of the contractor’s cost experience in performing the contract. This contract type places upon the contractor maximum risk and full responsibility for all costs and resulting profit or loss.
  • fixed price with escalation contracts – provide for upward revision of the stated contract price if certain price fluctuations (specifically defined in the contract) occur.
  • lump sum contract – provides a specified payment for completion of the work described in the contract documents.
  • unit-price contracts specify the amount to be paid for each unit of work but not the total contract amount.

The principal disadvantages of unit-price contracts are the requirement for accurately measuring the work actually performed and the fact that the precise contract cost is not known until the project is completed. A combination of lump-sum and unit-price provisions may be used in a single contract.

cost-type contracts are available in a number of forms. Some of these include:

  1. Cost plus a percentage of cost contract pays the contractor a fee that is a percentage of the project’s actual cost.  The higher the project cost, the greater the contractor’s fee.
  2. Cost plus fixed fee contract is the most widely used form of cost reimbursement contract. The cost plus fixed fee contract does not reward the contractor for an increased project cost but still fails to provide any incentive to minimize cost.
  3. Cost plus fixed fee with guaranteed maximum cost contract adds some of the risk of a fixed-price contract to the cost reimbursement contract because the contractor guarantees that the total contract price will not exceed the specified amount. Hence it is to be expected that the contractor’s fee for this type of contract will be increased to compensate for the added risk involved.
  4. Cost plus incentive fee contract is designed to provide an incentive for reducing project cost. In this type of contract, the contractor’s nominal or target fee is adjusted upward or downward in a specified manner according to the final project cost. Thus the contractor is rewarded by an increased fee if able to complete the project at a cost lower than the original estimate.

Under a Lump Sum or Fixed Price Contract, the contractor agrees to perform the work specified and described in the contract for a fixed price. The price of a fixed contract can only be changed upon the execution of a change order, under which the owner and the contractor either:

  • agree for the contractor to perform additional work that falls outside the scope of the original work for an agreed upon extra compensation or
  • agree to remove certain work from the original scope of work and reduce the price of the contract in proportion to the work that the contractor no longer has to perform.

These types of contracts are appropriate when a clear scope and a defined schedule have been reviewed and agreed upon.

The benefit of using Lump Sum or Fixed Price Contracts is that the owner’s construction costs are more predictable. The owner’s cost will be capped by the contract price, so long as no change orders are issued and no disputes arise on the project.

There are not many drawbacks with the use of the Lump Sum or Fixed Price Contract. To ensure that the Lump Sum or Fixed Price Contract fulfills this function, i.e., provides a predictable and accurate cost of construction for the owner, it is very important for the scope of work under the contract to be clearly defined. This will eliminate the owner’s risk of the contractor attempting to increase the contract price through the issuance of change orders for the performance of additional work that is arguably not part of the original scope of work but should be. Additionally, the schedule should clearly define the work and the deadlines that must be met. This could perhaps be a drawback to the use of the Lump Sum or Fixed Price Contract because it would require additional time and money to clearly define the scope of work and create a detailed schedule (though this is something that should be done on every construction project to protect the owner).

In addition, other types of contracts, such as Cost Plus Fee or Time and Materials Contracts, could arguably be cheaper if the actual cost of construction were less than the contractor’s estimated cost of construction on which the fixed price is based. But these types of construction contracts could also be more expensive if the actual cost of construction were to exceed the contractor’s estimated costs.

Therefore, the Lump Sum or Fixed Price Contract is a relatively safe and predictable contract type that could be used on a construction project.

4.1.5.      Format of Contracts

The following subjects may well be considered as somewhat typical of many construction contract documents though international projects usually have their own standards, usually FIDIC (International Federation of Consulting Engineers):

  1. Definitions (terms used in the contract documents)
  2. General Description of works
  3. Contract documents, intent, amending, and reuse
  4. Bid page
  5. Conditions of the contract (General and Special Conditions)
  6. Instruction to Bidders
  7. Bonds and insurance
  8. Contractor’s responsibilities
  9. Owner’s responsibilities
  10. Engineer’s status during construction
  11. Changes in the work (procedures)
  12. Change of contract price (pricing provisions)
  13. Change of contract times
  14. Warranty and guarantee; tests and inspections; correction, removal, or acceptance of defective work
  15. Payments to contractor and completion
  16. Suspension of the work and termination
  17. Dispute resolution
  18. Miscellaneous

The agreement describes the work to be performed, the required completion time, contract sum, provisions for progress payments and final payment, and lists the other documents making up the complete contract.

Government projects utilizes standard contract documents. The use of such standard contract forms will minimize the amount of legal review that the contractor must perform before signing a contract. However, even if the contractor is familiar with the standard contract forms being used, care must be taken to fully evaluate all special conditions as well as the plans and specifications.

In the Philippines we generally use one of the following standard forms of contract when engaging main contractors for construction works contracts:

  1. FIDIC (French initials for International Federation of Consulting Engineers) (1999) (Short contract and Red, Yellow and Silver Books). Mostly use for international construction contract. F´ed´eration Internationale des Ing´enieurs-Conseils (FIDIC)
  2. CIAP Document 102 Uniform Conditions of Contract for Private Construction
  3. UAP Document 301 (General Conditions)
  4. Standard Government Construction Contract RA 9184 developed by GPPB

4.1.6.      Conditions of Contract

The conditions of contract are the terms that collectively describe the rights and obligations of contracting parties (i.e. the employer and the contractor) and the agreed procedures for the administration of their contract. Contract conditions determine the allocation of risk and consequently, price. Typically, these conditions address the following:

  • The parties’ main responsibilities e.g., the employer provides the site and the right of access thereto while the contractor provides the works in accordance with the requirements established in the contract.
  • The timing of the works, e.g. start date, time for completion, period for defects liability, etc.
  • Testing and remedy of defects.
  • Payment, e.g. manner in which the works are to be assessed and certified, time for payment and interest on overdue amounts.
  • Variations and claims, e.g. the manner in which variations to the contract are to be evaluated and paid for and how the costs which result from employer liabilities are assessed and paid for.
  • Title (ownership) to objects, materials within the site, etc.
  • Risks and insurances, e.g. what are the employer’s and contractor’s risk and what insurances each party will take out.
  • Termination, e.g. the reasons for termination, the procedures for termination and the payment to be made upon termination.
  • The resolution of disputes, e.g. by adjudication, mediation, arbitration, litigation (court of law) or a combination thereof.

Classification of Contract Conditions

  1. The General Conditions contain those contract provisions applicable to most construction contracts written by the owner.  The “General Conditions” describe the general requirements for both the Contractor and the Owner that are applicable to all contracts. They have been standardized to enhance familiarity for all persons involved. Highlights of the “General Conditions” include:
    • The responsibilities of the Contractor relating to items such as control of Work, control of materials, work by others, legal responsibilities and permits, inspection of the Work and defective work.
    • The General Conditions also deal with contractual relations between Owner and the Contractor and with items such as bonds and insurance requirements, and how completion dates and contract quantities can be adjusted.
    • The General Conditions specify terms of payment to the Contractor, and if necessary, how the Contractor is to be compensated for Extra Work.
  2. The Special Conditions contain any additional contract provisions that are written for the specific work that is specific to the project. Special Provisions and information on contract drawings are set out for each project and can vary from contract to contract, even though the Standard Construction Specifications are uniform.
    • Special Provision clauses will usually include the Scope of Work associated with project specific work that is to be completed. Usually, this project specific work is not covered in the Standard Construction Specifications.
    • The Contractor is expected to provide all labor, equipment and materials required to compete this project specific work.