PROJECT MANAGEMENT TOPIC 3: CONTRACT ARRANGEMENTS 3.

1 Simple Contracts
A simple contract consists of an agreement entered into by two or more parties, whereby one of the parties undertakes to do something in return for something to be undertaken by the other. A legally binding contract consists of a valid offer from a contractor and an unconditional acceptance on the part of the client. There must be a form of consideration. For example, for goods and services rendered by one party and payment by the other. The parties to a contract must have proper capacity to enter into legal relations. The objective of the contract must be possible and it must not be made under duress. A simple contract may be in writing (not under seal), oral or implied from the conduct of the parties. It is obviously far more preferable from the contractor's point of view to enter into a written contract rather than an oral one. Although oral contracts are binding in law, they can nevertheless lead to trouble when used to govern a contract in the construction industry since a frequent cause of dispute is the oral ordering of variations and extensions to existing contracts which are not confirmed in writing. A formal contract is made by a deed and is legally binding by virtue of the form in which it is presented and hence does not require support by consideration.

3.2 Building Contracts

The two parties of a building contract are the client (also known as developer, owner or employer) and the main contractor. The Architect or Engineers are appointed by the employer according to the conditions of the contract to act as the agent of the client. The contract may require the main contractor to sub-contract certain parts of the work to nominated sub-contractors selected by the employer. The nominated sub-contractors will enter into a standard sub-contract with the main contractor. The main contractor is responsible for the nominated sub-contractor's conduct and performance. The main contractor is allowed a percentage of the prime cost (a PC sum tendered by a sub-contractor) to cover his profit and attendance. The Architect/Engineer gives instructions to nominated sub-contractors through the main contractor.

3.3 Termination of Offer

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PROJECT MANAGEMENT TOPIC 3: CONTRACT ARRANGEMENTS

It is important to know that invitation to tender by the employer is NOT an offer. It is an invitation to offer. The tender submitted by the contractor is the offer. The Common Law allows the contractor to terminate his offer in one of four ways: a) Revocation The contractor making the offer is free to withdraw his offer at any time before it is accepted, even though he has promised to keep the offer open for a specified time. b) Lapse Due to Time The tender submitted by the contractor normally includes a validity period. The offer will automatically expire after the time limit if it has not previously been accepted. c) Rejection The client can reject an offer and is not required to give any reason for his rejection. Once the offer has been rejected, the rejection is irrevocable, and the client is unable to change his mind and demand the contractor to enter into an agreement. d) Death of Contracting Party If the contract is offered by a person and he dies before his offer is accepted, the offer will be terminated.

3.4 Types of Contract

There are several types of contract with the main difference being the way in which the sum is to be paid to the contractor. The method of payment will affect the risks of contractor and the incentive for contractor to provide quality work. The main types of contract arrangement can be categorized as: a) b) c) d) e) f) Lump Sum Contract (Fixed Price Contract) based on bills of firm quantities Lump Sum Contract (Fixed Price Contract) based on schedule of rates Lump Sum Contract (Fixed Price Contract) based on drawings and specifications Measurement Contract based on bills of approximate quantities Measurement Contract based on schedule of rates Cost Reimbursement Contract (Prime Cost Contract)

PROJECT MANAGEMENT TOPIC 3: CONTRACT ARRANGEMENTS

3.4.1 Lump Sum Contract based on bills of firm quantities The lump sum contract is a fixed price contract. The contractor is paid the contract sum regardless of the actual cost incurred in completing the work, providing there are no variations. The contractor has to take into all contractual risks involved. Characteristics a) The design team needs to complete the detail design before the QS can prepare the BQ. b) Bills of Quantities of work prepared as accurately as possible from drawings and specifications. c) The BQ provides the quantities of each item of work. d) The contractor enters the unit rate for each item. e) The total sum (tender sum) is then computed f) If the actual quantity of work is different from the BQ, there will be no adjustment of contract sum and the contractor will be paid the exact contract sum. Advantages a) The employer knows his exact financial commitment at the end of the project. b) The contractor knows the scope of the work and price competitively. c) The employer knows the scope of work, the breakdown of the sum and the price of each item. d) The price quoted by the contractor can be used in variation work if required. Disadvantages It takes time to complete the detail design and prepare the bill of quantities. b) The employer may need to change his requirements during the design stage. The BQ has to be changed. c) The contractor is not paid according to the actual work done but his estimated tender sum during the tendering stage.
a)

Application a) When there is sufficient time to prepare detailed design with accurate quantities being measured. b) When the employer's financial commitment must be known for approval of proposed expenditure or for loan processing. c) It is commonly used in government building and civil projects and small to medium size private projects.

PROJECT MANAGEMENT TOPIC 3: CONTRACT ARRANGEMENTS

3.4.2 Lump Sum Contract based on schedule of rates

It is lump sum contract which the details of the design are not sufficient to prepare the bill of quantities. Instead a schedule of rates is provided which the contractor is required to estimate and enter the quantities of work and the unit prices of the work. The contractor has to carry more risk than a lump sum contract based on firm quantities. Characteristics a) The design team needs to complete sufficient drawings and specifications for the QS to prepare the schedule of rates. b) The schedule of rates should provide all major items of work. c) The contractor estimate the quantity required for each item according to the drawings and experience. d) The contractor enters the unit rate for each item. e) The total sum (tender sum) is then computed f) If the actual quantity of work is different from the estimate there will be no adjustment of contract sum and the contractor will be paid the exact contract sum. Advantages a) It takes less time to prepare the schedule of rates. b) The employer knows his exact financial commitment at the end of the project. c) The contractor knows the scope of the work and price competitively. d) The employer knows the scope of work, the breakdown of the sum and the price of each item. e) The price quoted by the contractor can be used in variation work if required. Disadvantages a) The contractor needs to carry more risk and demand higher profit. b) The contractor is not paid according to the actual work done but his estimated tender sum during the tendering stage. Application When there is not sufficient time to prepare the bill of quantities. b) When it is difficult to take off the quantities from the design drawings, for example air-condition, fire protection, building automation and electrical systems. c) This type of contract is commonly used in M&E projects.
a)

PROJECT MANAGEMENT TOPIC 3: CONTRACT ARRANGEMENTS

3.4.3

Lump Sum Contract based on drawings and specifications

It is lump sum contract which there is no detail design. The contractor has to complete the project and will be paid fix a sum according to the drawings and specifications given. Characteristics a) It is the simplest type of contract. b) It is a lump sum contract without bill of quantities. c) The tenderers estimate the required items and quantities to obtain the tender price. d) The contractor undertakes to complete all the work as given in the drawings with material and workmanship according to the specification. e) The contractor assumes higher risks. Advantages Do not need to prepare the bill of quantities or schedule of rates. Work can commence early. b) Both parties have a clear picture of the final contract sum c) For the client, the contractor will bear any additional costs which cannot be foreseen before the work commences. d) The client pays a fixed price regardless of the actual cost.
a)

Disadvantages There is no breakdown of the tender sum. The client does not know the detail of the costing. b) If the client asks for any variation work, there is no rates for reference. The contractor may quote a very high price. c) It is not suitable for work which contains many uncertain elements. d) The contractor may tender a higher price to cover for the risks of overlooking items or unforeseeable events.
a)

Application
e) f) g)

This type of contract is only suitable for: Small jobs (up to $500,000), like renovation work The work can be clearly defined. The job is urgent projects and requires early completion.

PROJECT MANAGEMENT TOPIC 3: CONTRACT ARRANGEMENTS

3.4.4

Measurement Contract based on bills of approximate quantities (It is also called re-measurement contract)

In the measurement contract the contractor is paid according to the actual quantity of work completed on site instead of a specific sum of money is stated in the contract. Characteristics a) The design team needs to complete the design to a stage that the QS can prepare the approximate BQ. b) Bills of Quantities of work prepared according to drawings and specifications. c) The BQ provides the approximate quantities of each item of work. d) The contractor enters the unit rate for each item. e) The total sum (tender sum) is then computed f) The actual quantity of work is verified on site by the QS. The contract sum will be adjusted and the contractor will be paid according to the work done. Advantages Construction work can commence earlier than the lump sum contract. b) The employer has more time to make decisions. c) The contractor is paid for actual work done. d) Unit rates can be used for valuation of variation work.
a)

Disadvantages The employer is less certain about the final project cost. b) The contractor is less certain about how much he can receive and his profit. c) The works have to be measured by the QS. It needs time and resources. The cost will be paid by the employer. However the amount will be small compare with the total contract sum. d) The architect has more opportunities to make changes and may lead to higher project cost.
a)

Application The employer wants to start construction early and there is insufficient time to measure the quantities accurately b) When some scope of works and some quantities are not clearly identifiable at the time of tendering. c) It is a popular type of building contract in private sector.
a)

PROJECT MANAGEMENT TOPIC 3: CONTRACT ARRANGEMENTS

Measurement Contract based on schedule of rates Characteristics
a) b) c)

d)
e) f)

It is similar to bill of quantities without the quantities. It consists of a list of items of work with full description, units of measurement and unit rates. The tenderers insert the mark-up percentages or the unit rates for each item. The actual quantity of the work item on site will be measured. Total cost will base on the unit rates and the quantities of work. The unit rates will be valid within the period specified in the contract. The contract therefore also called term contract. Standard Schedule i) The employer supplies a standard schedule of work. It includes unit rates for each item of work. ii) Tenderers specify a mark-up percentage against the listed rates to cover the overhead and profit in carrying out the work. 'Ad-hoc' Schedule i) A schedule of items of work is prepared by the employer for the work he intend to do, no rate is given. ii) Tenderers insert the unit rates against each of the item of work.

Advantages It does not need to ascertain the scope of work. b) Work can commence before completion of the design c) Enable contractor and designer to co-operate at the design stage
a)

Disadvantages It is difficult to make a fair comparison between tenderers, especially when there are no approximate quantities. b) Both parties do not know the final sum of the contract. c) The contract is required to commit the prices for a fixed time without knowing how much work will be given. The contractor has to quote a price higher to compensate his risks. d) Time and resources are required to carry out measurements for payment.
a)

Application It is suitable for jobs that actual quantities of work cannot be ascertained at the time of tendering. e.g. urgent repair and maintenance b) It may be used for jobs that that there is insufficient time to carry out the design there is uncertainty in the design details, but the employer wish to commence work soon. c) It is not commonly used in construction of new buildings. It is a popular form of contract in building and facilities maintenance.
a)

PROJECT MANAGEMENT TOPIC 3: CONTRACT ARRANGEMENTS

3.4.3 Cost Reimbursement Contract (Prime Cost Contract) Definition: Prime cost means the actual total cost to the contractor for buying materials, goods and components, of using or hiring plant and employing labour, in order to carry out the construction work. Characteristics
a) b)

c) d) e)
f)

The tenderers specify the mark-up percentage in their tender. When the employer wants the contractor to carry out a task, he will issue a works order. The work orders are usually given on a standard form. The contractor will provide an estimate with cost breakdown for the works order for the employers approval before he commence working. The work will be measured by an agent of the employer after completion. The contractor will be paid the prime cost of the work plus the agreed percentage. The mark-up percentage covers the overheads, supervision costs and profit of the contractor.

Advantages a) Do not need any design and drawings for tendering. b) The contract is usually a standard document. There is no preparation of contract documents and drawings. c) It allows early commencement of work. Disadvantages a) Parties have least precise indication of their commitments. b) The contractor has no motivation to lower the cost of work. Higher cost will give him higher income. Therefore it is considered as the most uneconomical type of contract. c) Requires tedious computation and certification of the total cost. d) Both parties are not certain of the financial commitment. Applications a) b) c) d) It is for urgent jobs when time is more important than cost. When the employer wishes to use a contractor he knows he can trust. It is used to carryout emergency tasks such as repairs to dangerous structures. For urgent alteration work where there is insufficient time or impractical to produce the necessary documentation. e) It can be used to supplement a term contract (e.g. measurement contract based on schedule of rates) when the work required is not available in the schedule of rates.

PROJECT MANAGEMENT TOPIC 3: CONTRACT ARRANGEMENTS

Types of Prime Cost Contract: i) ii) iii) Prime Cost plus Percentage Fee Prime Cost plus Fixed Fee Target Cost.

Prime Cost Plus Percentage Fee Contractor is paid the actual cost of the work plus an agreed percentage of the actual cost to cover for overhead and profit. It is the most common type of prime cost contract. It is fair to the contractor. The main drawback is that it is advantageous to the contractor to use more expensive materials and more labour to do the job. Prime Cost Plus Fixed Fee Contractor is paid the actual cost of work plus a fixed sum of money. The intention is to induce the work more efficiently. Target Cost Target cost is an estimate of the total likely cost, for example the one-year building maintenance cost of an office building. The tenderers specify the mark-up percentage. The contractor will be paid according to the prime cost plus the percentage. At the end of the contract, if the total cost less than the target cost, a bonus will be paid according to the amount of saving. A penalty will be deducted from the payable sum if the total cost exceeds the target cost.