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UNIT 4 COMPILATIONS
 Construction Contracts and contract Management

Contracts
A contract is a promise or a set of promises for the breach of which the law recognizes duty.
This amounts to saying that a contract is a legally enforceable promise.

Engineering Contracts
● An Engineering Contract is a mutual agreement negotiated between two parties for the
purpose of undertaking, on a commercial basis, certain clearly specified engineering work.
● In construction Industry “Project is sold before it is made”. In other words, the facility is
purchased before it is “manufactured” based on a set of drawings and work descriptors.
● The end item requires the purchaser to coordinate many entities to include designer(s),
contractor(s), specialty subcontractor(s) and vendors.
● Three party purchasing relationships (e.g., owner, designer and constructor) can lead to
an adversial relationship between the parties.

Essentials of a Valid Contract

● All contracts are agreements, but all agreements are not contracts because, the
fulfillment of certain requirements only gives an agreement a status of contract.
● We call such requirements as essentials of a valid contract.
● The primary aim of entering into a contract is to seek legal remedies.
● Therefore contract must be legally strong so that in case if a party does not fulfill
contractual obligations then necessary legal measures can be taken.
● The essentials of a valid contract are

i. Offer and Acceptance

ii. Free Consent
iii. Legal relationship
iv. Competent Parties
v. Legal Objective
vi. Lawful Consideration
vii. Possibility of Performance
viii. Certainty
ix. Writing and Registration

Void Contracts
● Contract restraining to exercise a lawful profession, business or trade.
● Contract in restrain of lawful marriage
● Contract restraining from using the privileges being used by public.
● Contract made in violation of the matter prohibited by prevailing law.
● Contract made for immoral purpose / against the public interest.
● Contracts made by incompetent persons.
● Contract made for unlawful considerations.

Contract Formation
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 ● When two parties mutually agree to transaction, a contract is formed.
● Negotiation for a contract is begun by the Principal inviting an offer.
● The formal offer made by a contractor in response to such an invitation is referred to as
tender.
● Reaching the final agreement may be a lengthy procedure - the negotiating parties
prepare and exchange documents setting out their respective requirements, offer and
counter offers.
● Documents must be carefully prepared so as to avoid misunderstandings and
misinterpretations that could lead to disputes during the contract stage.
● To ensure that the finally negotiated agreement is enforceable at law, the contract should
be clearly evidenced by writing down the agreed terms and conditions under an instrument
of Agreement to be signed by the parties to the contract.
● Thus “Contract” has also come to refer to the written document in which terms of the
promise are written down. By implication, both parties thereby accept certain
responsibilities and in return receive certain benefits.

Classification of Contracts
● Depending upon the magnitude and nature of the work, its special design needs, funding
requirements, complexities of the job and owner’s own preference, different types of
contracts are entered into.
● Contracts for any particular engineering project can be classified in the first instance as
Main Contracts or Subcontracts.
● The method of classification of Contracts are
● The method of payment for the work
● The method by which the contractor is selected.
● The method by which the responsibility is allocated

Classification by the method of payment for the work

● Lump sum contracts
● Schedule of rates or unit-price contracts
● Cost plus contracts
● Sometimes, Part Lump Sum and Part Unit-Price Contract

Lump Sum or Stipulated Sum Contracts

● The contractor based on the available complete set of plans and specifications quotes one
single price which covers all direct costs of the contractor for labor, machines, materials
and indirect costs such as field and front office supervision, secretarial support and
equipment maintenance and support costs and also includes profit of the contractor.
● In ‘fixed-price’ contract, the contractor accepts responsibility for all fluctuations in costs
and charges due to escalation, delays and other reasons and no additional payment will
be made to cover such costs.
● In contract ‘subject to cost adjustment’ provision may be made for additional payment
due to fluctuations in wages and conditions or for the cost of delays outside the
Contractor’s control.
● This lump sum amount may, of course, be increased or decreased owing to additions or
deletions from the scope of the work under the contract in accordance with the terms of
agreement.
● This type of contract is commonly used where the nature and extent of the work can be
accurately defined but the quantity of work cannot.

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 ● This type of contract is used primarily in building construction where detailed plans and
specifications requiring little or no modification can be developed.
● Contracts with large quantities of earthwork or sub surface work - not handled on a lump
sum basis.
Advantages
. From owner’s Point of View
● Owner knows the exact amount of money to be budgeted for the project
● Reduces the burden of accurate measurement for paying running bills
● Minimal involvement of owner.
● The contractor takes all of the construction risks
From Contractor’s Point of View
● Minimum interference from the owner
● An innovative contractor may obtain an opportunity to maximize profit through innovation.
● The contractor may pass on much of the risks to the sub-contractors.
Disadvantages:
From owner’s Point of View
● Requirement to have detailed plans and specifications complete before bidding and
construction
● Leads to the difficulties in changing design or modifying the contract.
● Design usually does not benefit through Value Engineering.
● Overall design-construct time is usually the longest.
● Changes to the work or unforeseen difficulties leads disputes/ litigation
From Contractor’s Point of View
● The owner controls the funding on disputed extra work
● The contractor usually bears the economic risks of unusual weather conditions, strikes or
other external factors
Schedule of Rates or Unit- Price Contracts
● The contractor quotes the price by units
● A guide quantity is given for each work item.
● Based on guide quantity, contractor quotes a unit price
● The total price is computed by multiplying the unit price by guide quantity and summing
up the cost of whole the items.
● The lowest reasonable bidder is determined and the contract is awarded.
● In unit price contracts, the progress payments for the contractors are based on precise
measurement of the field quantities placed.

Advantages
From owner’s Point of View
● Permits variable amounts of work to be paid fairly and equitably
● The owner may benefit from price competition
● Minimal involvement of owner.
● Flexibility in accommodating the variations.
From Contractor’s Point of View

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 ● There is minimum interference from the owner
● The contractor may pass on much of the risks to the sub-contractors.
● The precision of the quantity takeoff need not to be as exact as in fixed price.
● The contractor can maximize the profit by manipulating / unbalancing the bid.
Disadvantages
From owner’s Point of View
● Design does not benefit from Value Engineering.
● Overall design-construct time is usually the longest.
● Changes to the work / unforeseen difficulties leads in disputes /litigation
● No precise final price for the work until t completion
● The contractors can manipulate contract by Unbalancing the Bid.
● Car telling /round formation by bidders negate the fair price competition.
From Contractor’s Point of View
● The owner controls the funding on disputed extra /changed works
● The contractor bears the risks of unusual weather conditions/ strikes
● Last minute telephone quotations may contribute to misunderstandings with material
suppliers and subcontractors.
● Some contracts combine the two methods of payment.
● Inclusion of a Provisional Sum makes the contract a Part Lump Sum and Part Schedule
of Rates Contract.

Cost plus Contracts

● In a Cost plus Contract, the contractor is reimbursed the actual costs incurred in carrying
out the work under the Contract plus a fixed or variable fee to cover overhead costs and
profit.
● Four types of fee structure are common.
▪ Cost + Percent of Cost
● Cost+ Fixed Fee
● Cost + Fixed Fee +Profit Sharing
● Cost+ Sliding Fee
Advantages
Advantages from Owner’s Position
● Permits reduction of design-construct time
● Quick reaction by the contractor to major design changes / minimizes the adversary
position.
● Opportunity to utilize contractor expertise during the design phase to minimize overall
costs.
● The owner may participate fully in the management and control
● Under the guaranteed maximum price option, the owner may pass on some portion of the
construction risk to the contractor.

.Advantages from Contractor’s Position.

● Elimination of the risk inherent in fixed price contracting as a trade-off for a lower
guaranteed fee.

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 ● The contractor is paid for the preparation of his initial planning, including development of
cost-estimates, schedule and other work plan items which he most absorb in competitively
bid contract.
● Opportunity to obtain future work from the owner due to harmonious relationship.
● Job site can be staffed and managed efficiently with owner’s cost.

Disadvantages
Disadvantages from Owner’s Position:
● May not be the most economical in a competitive market.
● Disreputable, unskilled contractor can abuse this arrangement
● The guaranteed maximum, while theoretically setting a ceiling, may not stand up in the
event of poor initial scope, changed conditions, price increases, design delays or change
orders.
● Owner’s involvement is increased.
● Definition of reimbursable items of cost, particularly those for contractor’s tools and
equipment, overhead expenses etc. may be the sources of disputes and adversial
relationship.

.Disadvantages from Contractor’s Position

● Fees may be minimal in comparison to profit potential
● Planning and control functions and assignment of personnel are made increasingly difficult
because of the simultaneous nature of construction and design.
● Under the GMP, the contractor may bear risks for items not under his control. The owner
may resent amounts paid to contractor in event of large under run.

Classification by the method of selecting the Contractor

● Competitively Tendered Contracts
● Negotiated Contracts with the selected contractors.

Competitively Tendered Contracts

● The owner invites a quote for the works to be performed following a formal competitive
tendering procedure in which a number of tenderers submit bids based on complete plans
and specifications.
● The award of contract is generally made to the lowest responsible bidder and an
agreement is reached between the Principle and the Contractor.
● The word responsible is very important since the contractor submitting the lowest bid may
not, in fact, be competent to carry out the work.

Advantages:
● Selection of the low bidder ensures that the lowest responsible price is obtained.
● The major advantage, which is essential for public work, is that all bidders are treated
equally and there are no favorites
Disadvantages:
● The plans and specifications must be totally completed prior to bid advertisement.

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 ● Design usually does not benefit from Value Engineering
● Overall design-construct time is usually the longest

Negotiated Contracts
● A Negotiated Contract is one where the Principal negotiates directly with a contractor to
arrive at a mutually satisfactory agreement to undertake the work.

● A number of formats of contract can be concluded based on negotiation between owner

and contractors. It is possible, for example, to enter into a fixed-price or unit-price contract
after a period of negotiation. It implies flexibility on the part of the owner to select the
contractor on a basis other than low bid.

● The owner invites selected contractors to review the project documentation available at
the time of negotiation. Major items of negotiation are:
▪ Level and amount of fee
▪ Quality of the works to be performed.
▪ Projected time for completion etc.
● Although almost all types of contracts like fixed- price, unit-rate and cost plus fee can be
adopted, the most common form of contract concluded is the COST+FEE, since in most
cases, the design documentation is not complete at the time of negotiation.

Classification by Tech /Administrative Responsibility

● Engineering contracts can be classified by the manner in which the responsibilities are
allocated.
● Traditional
● Owner-Builder
● Design–Build or Design- Manage (Turn Key)
● Build-Own-Operate-Transfer (BOOT)
● Construction Management Contract

Traditional Approach
● A traditional procurement approach may be adopted where the clients design team is
appointed to prepare a detail engineering design, cost-estimates and specifications before
the choice of contractor is considered.

Owner-Builder Approach
● In this approach, owners perform both their own design work and some or all of the actual
construction with their own forces. This approach is often referred to as “force account”.
Examples are

Design–Build or Design- Manage (Turn Key)

● Project to contract with a single organization that would be responsible for design,
procurement, engineering and commissioning.
● “Turn a key in the door’ and project will be operational.
Advantages

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 ● The responsibility for the contract lies with a single firm and the promoter is relieved from
responsibilities for the equipment or plant and performance.
● The project is put into operation more rapidly than other contracts.
● Minimal owner coordination
● Great benefit to an unknowledgeable owner.
● Opportunity for construction expertise to be incorporated in design phase.
● Implementation of changes is simplified throughout the construction program.
Disadvantages:
● Usually no firm project cost is established until completion.
● Overall quality and performance may be subordinated to ensure profitability.
● Very few checks and balances from the owner side.
● The final result may not fully comply with expectations.

Build-Own-Operate-Transfer (BOOT)

● A project based on the granting of a concession by a principal, usually a government, to

a promoter, sometimes known as the concessionaire, who is responsible for the
construction, financing, operation and maintenance of a facility over the period of the
concession before finally transferring the facility, at no cost to the principal, as a fully
operational facility.(Smith and Merna, 1992)

Comparison of “Turn-key” and BOOT Projects

● BOOT projects are contractor financed turnkey contracts.

● In turnkey contracts, governments shift the risk to the private sector while still bearing the
risk of financing and operating the project. In a. BOOT project, the major risks of finance
and operation, however, borne by the promoter.

● In turnkey contracts, feasibility studies are carried out by the principal while in BOOT
project, the promoter will do that.

● Commercialization of a turnkey contract is the responsibility of the principal,. In BOOT

projects, the promoter will carry out commercialization.

● In turnkey contracts, operation of the facility is carried out by the principal after one or two
years of commissioning while in BOOT projects, the promoter will operate the facility over
the concession period before finally transferring the facility to the principal.
Advantages
● Promotion of private investment.
● Completion of projects on time without cost overruns.
● Good management and efficient operation.
● Transfer of new and advanced technology.
● Utilization of foreign companies’ resources.
● Additional financial sources for priority projects.
● No burden on public budget for infrastructure development.
● Positive effect on the credibility of the host country.

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Disadvantages
● Availability of experienced developers and equity investors
● The ability of governments to provide necessary supports
● The workability of corporate and financial structures.

Construction Management Contracts

● One form is retained to co-ordinate all activities from concept design through acceptance
of the facility.
● This approach unites a three party team consisting of owner, designer and CM in a non-
adversary relationship.
● The CM establishes the procedures for award of all contracts to architects/engineers,
principle vendors and the so-called trade contractors.
● Attractive to organizations that periodically build complex structures (e.g., hospital
authorities, municipalities etc.) but do not desire to maintain a full time construction staff
to supervise projects on recurring basis
● CM Contracts with owner will provide for full reimbursement of field costs plus fixed fee to
cover home-office costs and profit.

SUBCONTRACTS
OVERVIEW
Subcontracts have been an integral part of the building and construction industry in one form or another
since the middle Ages. The master stonemasons and carpenters who built the great cathedrals of Europe
were essentially ‘labor only’ subcontractors to the architect who was, in turn, not only the designer but
also the head contractor, or perhaps the construction manager, in a schedule of rates contract. In
Australia, subcontracts have assumed an ever-increasing importance since the 1950s. Many long-
established family building and construction firms began to incorporate, in a quest for the capital they
needed to finance their expansion and plant acquisition so as to be able to meet the demands of
changing technology. These firms frequently maintained a full stable of specialist ‘own trades’– teams of
skilled workers on the firm’s payroll, which worked exclusively for the firm within the confines of a single
trade. With corporate goals and strategies becoming more clearly defined, it soon became obvious to the
new building and construction companies that ‘own trades’ were not an economical proposition, since
these
Specialist teams, or at the very least their skeleton crews, had to be paid whether there was work for
them or not. The outcome of this was the progressive closing down and outsourcing of many of the
specialized own trades, and an increasing reliance on subcontractors which could be engaged as and
when required. Naturally, subcontractors were more expensive to use than own trades, but they were
only paid while their services were actually being used. This logic was also applied to the companies’ own
construction plant, which was also outsourced, but often retained under the contractor’s corporate
umbrella in the guise of a wholly owned plant hire company.
By the late 1960s, major contractors – and not a few smaller ones were beginning to operate as
managers of unrelated trade contractors. They were generally referred to in a project as the ‘head’
contractor, this being the company which had a direct contract – the ‘head’, or principal, contract – with
the owner. They employed
mainly management personnel and a few on-site laborers to carry out odd jobs, such as cleaning, which
remained a head contractor’s responsibility. Today, while the majority of subcontractors are very small,
the biggest, particularly in the area of mechanical and electrical services, are far bigger than most head
contractors.
This is about subcontracts, their role in the building and construction industry and the way in which they
are administered. It also examines the contract administration procedures applicable to the adjustment of
the contract sum and the payment to the contractor for changes in the value of work for which provisional
sums have

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Been allowed in the contract.
It presents the reader with a comprehensive view of the nature and role of different types of subcontract
and their administration and answers the following questions:
• Why are subcontracts used in the building and construction industry?
• What restrictions are there on the work in a project that may be subcontracted?
• What responsibility does the contractor have for the subcontracted work?
•What are the different types of subcontract which may be entered into by contractor and under what circumstances?
• What restrictions are there on the terms and conditions of a subcontract?
• In what circumstances may a subcontract be terminated?
• When are provisional and prime cost sums used; what is their purpose; and how are they adjusted?
• What are provisional quantities; and how are they used?

SUBCONTRACTS
A subcontract is a subordinate contract, within the context of a specific head (or main) contract, entered
into by the head (or main) contractor and a third party (the subcontractor) which will either execute work
or supply labor and materials or goods. Subcontracts may be either ‘domestic’ or ‘nominated’. A domestic
subcontractor is engaged by the head contractor entirely at its own discretion to carry out the work. The
selection of a nominated subcontractor, on the other hand, is reserved to the contract administrator or the
owner. In the latter case, the subcontractor is named (‘nominated’) in the contract documents and a
provisional sum is included in the contract sum to cover the anticipated cost of the work. The nominated
subcontractor must be engaged by the head contractor under a nominated subcontract.

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Project Risk Management

Risk and project management

Managing risk is an integral part of good management, and fundamental to achieving good business and
project outcomes and the effective procurement of goods and services. It is something many managers
do already in one form or another, whether it be sensitivity analysis of a financial projection, scenario
planning for a project appraisal, assessing the contingency allowance in a cost estimate, negotiating
contract conditions or developing contingency plans. Although many managers do not use the term ‘risk’
when they undertake these activities, the concept of risk is central to what they are doing. Better
management of risk and more successful activities are the outcomes. Systematic identification, analysis
and assessment of risk and dealing with the results contributes significantly to the success of projects.
However, poorly managed project risks may have wide-ranging negative implications for the achievement
of organizational objectives.
Risk should be considered at the earliest stages of project planning, and risk management activities
should be continued throughout a project. Risk management plans and activities should be an integral
part of an organization’s management processes. It is important for the project sponsor and the prime
contractor, and the main sub-contractors where relevant, to use effective and consistent risk management
processes. The processes should promote transparency and effective communication between the
parties to facilitate effective and expeditious management of risks.

There are three keys to managing project and procurement risk effectively:
• identifying, analyzing and assessing risks early and systematically, and developing plans for handling
them;
• allocating responsibility to the party best placed to manage risks, which may involve implementing new
practices, procedures or systems or negotiating suitable contractual arrangements; and
• ensuring that the costs incurred in reducing risks are commensurate with the importance of the project
and the risks involved.
The scope of risk management for projects includes risks associated with the overall business approach
and concept, the design and delivery of the project, transition into service, and the detailed operations
and processing activities of the delivered asset or capability.
• Business risks include all those risks that might impact on the viability of the enterprise, including
market, industry, technology, economic and financial factors, and government and political influences.
• Project risk includes all those risks that might impact on the cost, schedule or quality of the project.
• Operations and processing risks include all those risks that might impact on the design, procurement,
construction, commissioning, operations and maintenance activities, including major hazards and
catastrophic events.

Risk is exposure to the consequences of uncertainty. In a project context, it is the chance of something
happening that will have an impact upon objectives. It includes the possibility of loss or gain, or variation
from a desired or planned outcome, as a consequence of the uncertainty associated with following a
particular course of action. Risk thus has two elements: the likelihood or probability of something
happening, and the consequences or impacts if it does.
Risk management refers to the culture, processes and structures that are directed towards the effective
management of potential opportunities and adverse effects.
The risk management process involves the systematic application of management policies, processes
and procedures to the tasks of establishing the context, identifying, and analyzing, assessing, treating,
monitoring and communicating risk.
Risk identification is the process of determining what, how and why things may happen.
Risk analysis is the systematic use of available information to determine how often specified events may
occur and the magnitude of their consequences. It may use any of a wide variety of mathematical and
other models and techniques.
Risk evaluation determines whether the risk is tolerable or not and identifies the risks that should be
accorded the highest priority in developing responses for risk treatment.

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