CONTRACTS MANAGEMENT AS A SSESSME MEN NT OF RISKS WH W HILE PREPARING TENDER ESTIMATES “RED FLAG” CLAUSES K GANESAN
Tender Costing •
Usually the cost of tender items of work are calculated as below Material + Labour + Equipment + Power & Water + Overheads + Profit
Tender Costing •
Usually the cost of tender items of work are calculated as below Material + Labour + Equipment + Power & Water + Overheads + Profit
Tender Costing The above generally result in less than optimal pricing as the following major cost elements are NOT considered Taxes, Duties and other Statutory payments + Cost of Risks due to the various contract conditions & stipulations which are NOT separately reimbursed
Owner-Construction Contractor Prime
Contract “Red Flag” Clauses •
Before submitting the bid, the contractor should know what kind of contractual situation will be encountered if the bid is selected and contract awarded •
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Will the contract be fair, or will it be heavily biased in favour of the owner? Aside from the “risk of performance” associated with the actual construction work, what contractual risks lie buried in the contract language?
Owner-Construction Contractor Prime Contract
“Red Flag” Clauses •
Old adage: “Do not sign a contract until you have read and understood every single word” Not
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Preparation of cost estimate time consuming and expensive “Do not undertake a cost estimate and start bid preparation until you have read and understood the potential contract” Carefully examine and understand the provisions of certain key contract clauses – “red flag” clauses.
Important “Red Flag” Clauses •
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Time provisions Liquidated or actual damages for late completion Site availability and access to the site Payment and retention provisions Reports on physical site conditions Measurement and payment provisions Variation in quantities Escalation provisions
Important “Red Flag” Clauses •
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Changes to Contract scope Delays, Suspension and Extension to the Contract period Taxes, Duties and Changes in Legislation Exculpatory clauses Insurance and bond provisions Indemnification clauses
Important “Red Flag” Clauses •
Time provisions •
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Are project specific and are broader than simply a statement of how much time the contractor has been given to complete the work. Contractor should look at: •
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What are the notice to proceed (NTP) provisions? What is the time period after NTP within which the contract work must be completed? Is a single completion time for the total project specified or is a series of milestones listed that must be met within specified time limits, each milestone completion time pertaining to a discrete part of the contract work?
Important “Red Flag” Clauses •
Liquidated or actual damages for late completion •
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Type of contractor liability that will result in the event of late completion If the required contract work is not completed with in the stated period, the contract has, in effect, been breached by the contractor and the owner is entitled to be paid damages. Monetary amount by one of the following ways: •
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Most construction contracts include a liquidated damages provision If the contract does not contain a liquidated damages provision, the owner is entitled to be paid the actual monetary damages suffered due to late completion.
Important “Red Flag” Clauses Site availability and access to the site •
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Implied obligation of the owner is to make the project site and reasonable access to it available to the contractor at the time of notice to proceed without restrictions unless the contract contains provisions to the contrary. Certain contracts may restrict the contractor’s right to occupy the site to certain days and/or certain hours of the day.
Important “Red Flag” Clauses Payment and Retention Provisions Payment frequency Payment for value of materials and fabricated products Retained percentage provision Mobilisation advance Interest on delayed payments Final Payment All the above will impact the contractor’s cash flow and consequently the cost of carrying out the work •
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Important “Red Flag” Clauses Measurement provisions •
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Item rate contracts Basis of quantity measurement and exact rules determining which items of work will be separately paid and which will be included in payment for other items are very important •
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Usually found in the specifications
Procedures for recording measurements and levels of checking before certification and payment
Important “Red Flag Clauses
Changes Clause While most contract now-a-days has a changes clause, the details vary from contract to contract The clause generally defines The owner’s right to change the contract scope unilaterally Places limitations on that right Establishes the contractor’s duty to perform the change, and The right to be paid for performing the change.
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Vary from being even-handed to being grossly unfair
Important “Red Flag” Clauses Variation in quantities •
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Important in Item rate contracts where estimated quantities are large and can potentially underrun or overrun. Rates quoted by the contractors contain two components • •
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Direct cost of performing the work Component to cover contractor’s overheads and general and administrative expenses If underrun the contractor loses, and if overrun contractor gains Widely used clause provides that the bid price will apply if the work falls with in a range +/- 15% or 25%. Any variation beyond this, rates will be recalculated.
Important “Red Flag” Clauses Escalation provisions • •
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Long-term contracts Essential idea – in order to induce a lower bid price, the owner agrees to take the risk, or part of the risk, of increases in the cost of labour and key construction materials above the levels that existed at the time the bids were taken. Some contracts only provide for escalation on certain basic materials while many Govt contracts provide escalation on material prices, labour wages & cost of POL based on variation in cost indices Several contracts prohibit any additional payments towards escalation and require a “Firm Price” for the various items of work during the entire contract period including extended durations.
Additional “Red Flag” Clauses Differing Site Conditions Clause •
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Sometimes called “changed conditions” or “concealed conditions” clause. Normally applies to any physical site condition found during contract performance that materially differs from those indicated in the contract documents or from conditions normally encountered in that type of work.
Many contracts are either silent or they pass on all such risks to the contractor
Additional “Red Flag” Clauses •
Taxes, Duties & Changes in Legislation Most
of the contracts require the contract price to include all taxes and duties and other charges payable to various authorities In certain contracts, Service Tax and VAT (Value added Tax) is reimbursed on actuals in Legislation could involve Changes introduction of new taxes or ( even withdrawal of subsidies already provided) impacting the cost of carrying out the works. In CPWD contracts where escalation is payable, changes in tax rates, say, from 12% to 14% is NOT reimbursable
Additional “Red Flag” Clauses Foreign Currency Fluctuations Several
contracts include procurement of materials and equipment from overseas, whereas the payment terms define payments only in Indian rupees. Also in many No change – Firm price contracts no separate clause is included to allow for such exchange rate variations. As the foreign currency exchange rate is subject to market demands and volatile fluctuations, certain amount of contingency need to be included to account for likely exchange rate fluctuations.
Additional “Red Flag” Clauses Delays and Suspensions of Work
Construction contracts usually impose severe liabilities on the contractor because of generally stringent requirements of work to meet narrow technical standards within fixed time requirements. However, both owners and contractors understand that certain conditions may occur under which the contractor’s failure to perform within required time limits will be excused.
Additional “Red Flag” Clauses Delays and Suspensions of Work The clause usually enumerates what constitutes a reason for excusable delay Questions arise regarding responsibility for extra costs arising when the owner either delays or suspends the work. Who pays? Ranges from owner pays for delays caused by them to those that are completely silent of the issue to those containing “nodamages-for delay” clauses – limited to extension of time only.
Additional “Red Flag” Clauses Terminations and Partial Terminations •
Owner’s right to unilaterally terminate all of the work of the contract or to terminate some divisible part of the work. Usually under the following circumstances: Default of the contractor: When the contractor’s performance is either far behind a reasonable time schedule or results in work that fails to meet contract quality requirements, or when the contractor becomes financially insolvent. Called default terminations. The owner may terminate the contract without disclosing any reason. Called convenience termination. •
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What are the contractual relief/ compensation in case of Termination / Partial terminations??
Additional “Red Flag” Clauses Dispute Resolution and Governing Law Clause Who will resolve contract disputes and by what set of rules? A well drafted clause spells out Precisely what steps the contractor, architect/engineer, and owner will take to resolve disputes between them Define time limits within which various procedural steps must be initiated Extreme cases – contract states that that A/E’s or owner’s decision is final and binding. Whether legally enforceable depends on the laws and parties involved (public or private). •
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Additional “Red Flag” Clauses Dispute Resolution and Governing Law Clause
Means for dispute resolution Submittal to an administrative board of the owner-agency involved Submittal to a specially appointed contract disputes review board Arbitration Formal trial in a court of law •
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Important “Red Flag” Clauses •
Insurance and bond provisions •
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Usually, contractors will be able to meet the insurance requirements, provided they are not so stringent or unusual that the required policies are not available in the insurance market Insurance premium cost – must be included in the bid cost estimate Security bond requirements •
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Cost Whether the contractor will be able to obtain the bonds at all? Bid bond, performance bond, and labour and materials bond
Important “Red Flag” Clauses Reports on physical site conditions •
Especially crucial in projects involving underground construction
Exculpatory clauses or disclaimers •
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Many knowledgeable persons oppose this type of clauses and many courts are reluctant to enforce them However, their use persists Contractors who encounter them in contract documents and assume they will not be enforced do so at their peril
Important “Red Flag” Clauses Indemnification clauses Many contracts require the contractor to “indemnity and hold harmless” the owner and A/E from all losses that they may suffer arising from any act or failure to act of the contractor in performance of the contract Imposes serious potential liabilities on the contractor. Is the risk insurable? •
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Typical Contract Wordings •
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Escalation No escalation of rates will be entertained during the period due to any reason whatsoever. The rates will be final and firm till the period of construction. Same rates shall also be applicable for all other similar nature of works for new buildings/ extension of old building planned to be commenced at later stage but during the validity of this contract. The Contractor shall not be entitled for any additional payment / escalation due to extension of contract and also no compensation shall be paid for the said extension period. The Contract Price shall be deemed to cover any escalation in prices of materials, labour, consumable and any other inputs to the Works during the contract period including any extensions, and any claim by the Contractor for any escalation/additional costs shall not be admissible.
Typical Contract Wordings Interest on delayed Payment and Interest charges on withheld amount •
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No interest shall be payable by the OWNER on any sum due to the Contractor in terms of the Contract be it the security deposit, additional security deposit/ retention money, interim or final bills. The Owner, shall not, under any circumstances be liable to pay to the Contractor interest on any sum payable to the Contractor under or arising out of the Contract, whether upon the certificate of R.A. bills the Owner or otherwise, including the refund of earnest money, Performance Guarantee, Retention Money or payment of R.A. Bills or final bills etc.
Typical Contract Wordings Correctness of details •
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The CONTRACTOR shall be entirely and exclusively responsible for the horizontal and vertical alignment, the levels and correctness of every part of the WORK and shall rectify effectively any errors or imperfections there in, such rectifications shall be carried out by the CONTRACTOR at his own cost, when instructions are issued to that effect by the ENGINEER-IN-CHARGE Errors or omissions in Contract Documents or the wrong description of details of Work shall not relieve Principal Contractor from performing such omitted work or wrongly described details of the Work and they shall be performed as if fully and correctly set forth and described in the Drawings and the Technical Specifications. The cost of such work shall be included in the cost of the Work, but in no event shall such work entitle Principal Contractor for extra claims.
Typical Contract Wordings Taxes & Duties •
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No exemption or reduction of customs duties, excise duties, sales tax, sales tax on works CONTRACT quay or any port dues, transport charges, stamp duties or Central or State Government or local Body or Municipal Taxes or duties, taxes or charges (from or of any other body), whatsoever, either prevailing as on date and/or as may be levied in future will be granted or obtained, all of which expenses shall be deemed to be included in and covered by the schedule of rates. All Duties, Taxes and other Levies payable by the Contractor under the contract or for any other cause, shall be included in the Total Tender Price submitted by the Tenderer. Any Variation during execution in above duties/ taxes / other levies not be considered
Typical Contract Wordings Foreclosure of Contract due to Abandonment or Reduction in Scope of work •
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The Contractor(s) shall have no claim to any payment or compensation whatsoever on account of any profit or advantage which he/they might have derived from the execution of the work in full as specified in the tender but which he/they did not derive in consequence of the increases or decreases of the works nos. of dwelling unit by reasons of alterations, omissions or variations or in consequence of the full amount of the work not having been carried out. If at any time after acceptance of the tender, Engineer-inCharge shall decide to abandon or reduce the scope of the works for any reason whatsoever and hence not require the whole or any part of the works to be carried out, the Engineerin-Charge shall give notice in writing to that effect to the Contractor and the contractor shall act accordingly in the matter. The contractor shall have no claim to any payment of compensation or otherwise whatsoever, on account of any profit or advantage which he might have derived from the execution of the works in full but which he did not derive in consequence of the foreclosure of the whole or part of the works.
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Suspension/ Foreclosure /Termination CONTRACTOR shall not be entitled to claim compensation for any loss or damage sustained by him by reason of temporary suspension of the WORKS aforesaid. An extension of time for completion, corresponding with the delay caused by any such suspension of the WORKS as aforesaid will be granted to the CONTRACTOR should he apply for the same provided that the suspension was not consequent to any default or failure on the part of the CONTRACTOR The decision of the Engineer in charge shall be final on the amount of compensation payable on account of any idle labour /employees and idle plant/machinery. Recovery of installments towards all advances shall remain suspended during the period the suspension of work lasts, and no interest on advance shall be charged for the said period of suspension. Apart from this, the contractor has no other remedies in connection with suspension.
Typical Contract Wordings Variations in Quantities •
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The quoted rates shall not alter on account of any variation/deletion/ substitution nor shall it vitiate the work order in any way. It is stressed that no escalation or claim for loss, compensation on grounds of increase/decrease in the quantities will be entertained under any circumstances, nor will the contractor be entitled to prefer any claim. Variation limit to be ± 25% of total Contract Value & no limit of the contract items within the BOQ. EIC/owner reserves the right to alterations , omissions, deductions or additions , in part or in whole any of the quantities or to totally omit any /most items of work and the contractor shall not claim any extra or damages on these grounds.
Typical Contract Wordings Commencement on Site/Possession of Site •
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The Employer shall hand over complete or part possession of the site to the Contractor 7 days in advance of construction programme. At the start of the work, the employer shall handover the possession of at least 75% of the site. If there is delay in handing over the Site, in full or in part, the Owner shall grant reasonable extension of time for the delay in the completion of Works but the Contractor shall not be entitled to claim any compensation, whatsoever in this regard.
