Topic 2.1 Contracts and Payment Structure

Topic 2:
Contracts and
Payment
Structure
Dr. Abdulrahaman Alsharjabi

OBJECTIVE OF THIS
TOPIC:
Define the contracts structure based on the
procurement methods or routes.
Describe the other dimension of contract
forms and the different methods of pricing
contracts.
Analyze how progress is measured and
payments made as the project progresses.
Examine the factors to be looked into when
choosing the contract forms.
Introduct
ion
In this chapter we consider
the types of contract
structures adopted, different
pricing regimes and the
terms of payments. We also
describe the issues to be
considered when selecting
the different options.
Factor affecting
contracting
The nature of the contract
depends on:
Scope of the work,
The responsibility of the
contractor,
The risk involved
The urgency
Contract
Structures
When choosing to use contractors, the
purchaser may follow one of several
procurement routes, distinguished by
the following features:
1- Whether responsibility for the design,
procurement, construction and
commissioning is placed with one organization,
or is to be divided between several, separate
organizations.
Contract
Structures
2- Whether the main contractor will both
manage the project and undertake
construction, or will be responsible for the
management only with the construction
work undertaken by others, working either
as subcontractors to the main contractor
or as separate contractors employed
directly by the client.
Contract
Structures
3- The basis upon which
payment is to be made.
Commonly Routes
Used in Procurement
Route 1. The traditional system:
Used in building and civil engineering contracts where
the design responsibility is primarily that of the
architect or engineer employed by the client and the
contractor or contractors are primarily responsible for
construction only
Route 2. The turnkey contract :
This is where a single firm is employed by the client to
undertake the design, procurement, construction and
commissioning of the entire works, including managing
the process.
Commonly Routes
Used in
Procurement
Route 3. The design and build contract:
Equivalent to 2. above, in the building and civil engineering
industry. Here, the contractor is responsible for design as
well as construction.
Route 4. Construction management and
management contracting:
Similar to 3. above, in that the contractor is responsible
only for the management of the contract, with all
construction work done by others.
5. Guaranteed maximum price
Combines construction management with design and build.
In outline this is typically as follows.
Factors for Selecting
Specific Method
The appropriate methods for a
particular projects depends on:
1. The method of financing.
2. The need to ensure the earliest
feasible date of completion.
3. The need to ensure the lowest
initial capital cost.
4. Certainty of the out-turn costs.
Specific Method
1. The method of financing:
If the project is financed by non-recourse
financing, that is the project itself provides
the security for the loans, the banks are
almost certain to insist on a turnkey route
so the entire design is the responsibility of
the contractor and the clients only
responsibility is the preparation of their
statement of requirements.
Specific Method
2. The need to ensure the
earliest feasible date of
completion:
The quickest method is construction
management with the contractor
responsible at least for the management of
design. This allows design and construction
to proceed in parallel. It does not, however,
provide the client at the outset with a firm
price.
Specific Method
3. The need to ensure the lowest
initial capital cost:
This is most likely to be achieved using the
traditional method although there is a risk that
the consultants design may not be the most
economic since it will not have been tendered
in competition. On the other hand, a
contractors design might not take account of
the lifetime costs. There is also the risk of
variations and claims which can cause the out-
turn cost substantially to exceed the initial
Specific Method
4. Certainty of the out-turn costs:
This is most likely to be achieved
through the use of the turnkey
method which is why it is favored by
the banks.
The Contract
Price
There are three main ways in which
the contract price may be expressed or
calculated:
1. Lump sum.
2. Re-measurement, schedule of rates or
bill of quantities.
3. Cost reimbursement.
On a single contract the different ways
may be combined.
1. Lump
Sum
It establishes the amount of the
commitment in advance, it provides
the maximum incentive to the
contractor to complete the work on
time and it reduces to a minimum
the amount of administration
involved after the contract has been
let. However, these benefits will be
obtained only if it has been possible
2.Re-measurement,
schedule of rates or
bill of quantities
In standard forms of building contract, where
quantities form part of the contract, the contract
price is a lump sum, not for the building as a
whole, but for the stated quantities of work
described in the bills of quantity. These quantities
are an accurate estimation of the work to be
performed by the contractor except where any
quantity is stated to be approximate. If greater
quantities of work are necessary to complete the
works, then the contractor is entitled to be paid
extra under the variations clause in the contract.
3. Cost
Reimbursement
Where the facility delivered will earn
substantial revenue, finishing by the
earliest possible date is regarded as
more important than obtaining the
lowest capital cost. Yet the extent of
the lack of definition of the project or
the anticipated risks are such that it is
impractical to expect the contractor to
assume the risks of even a
Terms of
payment
There are a number of advantages to this
approach:
1. The employer avoids having to restrict the tender list
to large firms possessing the resources to finance the
contract, whose overheads and prices are likely to be higher
than those of smaller companies (this assumes, of course,
that such smaller companies are otherwise technically and
commercially competent to carry out the work).
2. It ensures that the tenderers do not have to inflate
their tender prices by financing charges. In many instances,
the rate of interest which the contractor has to pay when
borrowing will be higher than that paid by the employer.
Terms of
payment
There are a number of advantages to this
approach:
3. It gives encouragement to and allows the
employer to take advantage of firms possessing
technical initiative who would otherwise be held
back from expanding by lack of liquid cash..
4. The employer minimizes the risk of being
saddled with a contractor who has insufficient
cash with which to carry out the contract and of
having therefore to either support the
contractor financially or terminate the contract.
Paying at the
End of the
Contract
Two arguments used to support the case
for only paying at the end when the
contract is complete:
1. Payment on completion provides the
contractor with the best possible incentive to
finish the whole of the work by the date for
completion. It is far more effective than
imposing liquidated damages for delay.
Paying at the
End of the
Contract
Two arguments used to support the case for only paying at
the end when the contract is complete:
2. (a) Paying monthly as the work proceeds, as is normal in
building and civil engineering contracts, has encouraged the
establishment of small contractors who do not possess the
technical and managerial competence to undertake the work,
tender low, uneconomic prices and lack the cash resources to fund
the work when they run into difficulties.
(b) It is too easy to set up as a builder by hiring labor on a self-
employed subcontract basis and the necessary plant, and buying
materials on credit terms which mean that they are in fact paid for
by the purchaser. Such firms do not last very long, but their
presence while they are in business is one of the reasons why tender
prices are uneconomic and too low to support the required level
of investment, especially in training. They are also a prime cause
of the adversarialism and claims culture prevalent in the industry.
DELAY IN
PAYMENT
Where the contract provides for payment to be
made against some clearly defined event, and for
the payment to be within a specified period of that
date, there is no excuse for delay in payment.
The specified date may be either from the issue by
the architect or engineer of a certificate of
completion or from receipt by the purchaser of an
invoice which the contractor was entitled to submit,
depending on the contract.
Late payment is quite simply a breach of contract,
although one of the commonest committed. Many
contracts do in fact provide for the payment of
ADVANCE
PAYMENTS
The general rule is that payments
made in advance of the contractor
starting work or of delivery of
equipment to site should be
avoided so far as possible.
If for commercial reasons such
payments have to be made, then
they should always be secured by
PROGRESS PAYMENTS
DURING
MANUFACTURE
On contracts which include the manufacture of plant, it is
again suggested that progress payments in advance of the
actual delivery of such plant to site should be avoided.
The primary reason is the purchasers lack of security for such
payments and the difficulties of recovering them if the
manufacturer gets into financial difficulties. If for commercial
reasons it becomes necessary to make such payments, then:
Plant to at least the value of the payment should be identified, marked
as such, separately stored and the contract should state that on payment
it becomes the property of the purchaser;
Such plant should, however, also be stated in the contract to remain at
the risk of the manufacturer until at the earliest it has been delivered
to site and may be depending upon the contract until the works as a whole
have been accepted by the purchaser.
RETENTION
MONEY
With contracts for building and civil engineering works and
large contracts for supply and installation of plant and
equipment, it is usual for the purchaser to retain a proportion of
the contract price until the work has been completed, passed its
tests (if any) and accepted by the purchaser.
The retention percentage varies but is usually between 10 per
cent and 20 per cent. On acceptance, half of this money is
normally released and the balance held during the defects
liability period as security for the performance by the contractor
under their obligations to make good any latent defects which
appear in the work.
Money is released at the end of this period provided that all
defects have been remedied to the purchasers satisfaction.
Contractors often ask for the second half of the retention money
to be released to them on completion against a bank guarantee.
Summary
Definition of project and reflections on contract
and various types of contract structure according
to contract strategies such as turnkey, design
and build, management contracting, BOT, etc.
Types of contract pricing:
o Lump sum
o Bill of quantities (measurement)
o Cost of reimbursement (cost plus)
Terms of payment based on certain approaches.

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Dr. Abdulrahaman Alsharjabi

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