Construction Contract and Types of Contracts

Mon, 06/27/2011 - 07:45 — Decknash

Definition of a construction contract

The term Contract used in the Construction management can be defined as: “An agreement entered into by two parties under the terms of which one party agrees to perform a specific job for which the other party agrees to pay. Contract documents attached to and/or stated in the agreement form integral parts of the contract”.

Contract

Essentials of Contract validity

* The parties to the contract must be competent, and legally capable of playing their intended part. The law can not enforce the agreement on someone who has not the legal capacity to enter into an agreement. This could be due to infancy, lunacy, drunkenness, or being restricted from entering into such agreement by a prior in date agreement or scope of authority.
* The subject matter of the contract must be lawful and definite in respect of requirements and duties of each party. For example a contract violating municipal regulation is not binding and is void in courts. Also uncertainty in respect of the what is wanted may result in the contract being not enforceable by law.
* Proposal and acceptance: There must be a proper proposal by one party and its absolute and unqualified acceptance by the other party. The proposal is not binding without a clear acceptance and is not binding beyond its date of validity.
* Free consent of parties to the contract: Consent is said to be free when it is not caused by force, or undue influence or fraud or misrepresentation.

Breach of Contract

Breach of Contract is the failure to perform it. However, not every failure to perform an obligation amounts to a true breach, as there are a number of excuses for non performance. When a contract has been broken without sufficient excuse or justification, the party who suffers by such breach is entitled to receive from the party in default, a compensation for any loss or damage caused by such breach.

Data Required for Preparing an Estimate:

A Contract may be terminated or brought to an end in either of the following ways:

* Full and satisfactory performance by both parties to their obligations under the contract.
* Breach of contract, when the default of one party releases the other party from the contractual obligations.
* Mutual agreement of the parties to terminate the contract.
* Unforeseen circumstances beyond the control of either party render it impossible to perform his duties or obligations stated in the contract.
* Operation of law to terminate a void contract.

Types of contracts commonly used in construction

* Lump sum contract
* Item rate or unit price contract
* Percentage rate contract
* Cost plus percentage rate contract
* Cost plus fixed fee contract
* Cost plus fluctuating fee contract
* Target cost contrac.

EXPLAIN UNIT PRICE (ITEM WISE) CONTRACT?
This kind of Contract is based on estimated quantities of items included in the project and unit prices which have been agreed to. The final price of the project is dependent on the quantities of the items needed to carry out the work. The terms of this type of Contract often accommodates flexibility for price adjustment. The agreed to value may be subject to amendment if the volume is reduced or exceeds the original negotiated terms and price.

WHAT ARE THE ADVANTAGES OF UNIT PRICE CONTRACT?

The Architect is involved in this type of Contract because it is he who provides the quantities of each item (in the Bill of quantities), and negotiates the unit prices with the Contractor. Moreover, in this type of Contract, the Owner makes payments to the Contractor only after the Architect has verified the measurements at Site and certified the Contractor’s bills for payment. This way the Owner is safe as he is paying only for the volume of work done at site and not paying anything extra. Also, he is assured (because the Architect is involved), that the quality of the work will be upto the mark.
In this type of Contract, the Contractor has to initially invest his own money for starting the work, and so the Owner need not worry about giving the Contractor a big advance.
In general this Contract is considered the most scientific and most suitable for construction projects where the different types of items, but not their numbers, can be accurately identified in the Contract documents.
The Contractor is also safeguarded against any contingencies, or variations in labour or material rates.

WHAT ARE THE DISADVANTAGES OF THE UNIT PRICE CONTRACT?

The Contractor has to invest his own money initially.Though this is one of the most preferred Contracts in Constuction/Buildings, it is not unusual to combine a Unit Price Contract for parts of the project with a Lump Sum Contract or other types of Contracts.WHAT IS

A LUMP SUM (FIRM FIXED PRICE) CONTRACT?
With this kind of Contract the Contractor agrees to do the construction and completion of the building at a designated time for a fixed price or Lump Sum. Also named “Fixed Fee Contract”, this type of Contract is often used in Building Contracts. Fixed Fee or Lump Sum Contract is suitable if the scope and schedule of the project are sufficiently defined to allow the estimation of the project costs.The scope of the Contract defines the expectations of both parties. This type of Contract provides a degree of certainty for both parties because the Contract clearly spells out what is involved.

WHAT ARE THE ADVANTAGES OF LUMP SUM CONTRACT?

A lump sum Contract provides 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.
Since the price is fixed, any unforeseen contingencies or variations in material or labour prices do not affect the Owner.
It provides maximum incentive for the Contractor to control costs and perform effectively and imposes a minimum administrative burden upon the Contracting parties.

WHAT ARE THE DISADVANTAGES OF THE LUMP SUM CONTRACT?

An Architect is not involved as this Contract is an agreement between the Owner and the Contractor for a final fixed price. So the Architect does not have a role to play , and so quality of work cannot be checked and controlled by an expert.
Since specifications are not clear, the Contractor can use alternative/inferior brands of materials.
Also there is a lot of ambiguity in the specifications, measurements, mode of payment, etc.
Though the Contract is made on a fixed price, the Contractor may claim extras by giving different reasons, since the specifications, measurements are not clear.
The Contractor takes money in advance from the Owner, and then he proceeds with the work at his own pace. Also sometimes, the Contractors deliberately hold up work towards the end, so as to extract maximum money from the Owner. So the Owner feels helpless as his money is with the Contractor.
A lump sum Contract can be used in conjunction with an award-fee incentive and performance incentives, when the award fee or incentive is based solely on factors other than cost. The Contract type remains Lump Sum when used with these incentives. A lump sum Contract, shall be used when the risk involved is minimal or can be predicted with an acceptable degree of certainty. However, when a reasonable basis for firm pricing does not exist, other Contract types should be considered, and negotiations should be directed toward selecting a Contract type (or combination of types) that will appropriately tie profit to Contractor performance.

WHAT IS A LUMP SUM CONTRACT WITH PRICE ADJUSTMENT?

It provides for upward and downward revision of the stated Contract price upon the occurrence of specified contingencies. A lump sum Contract with economic price adjustment may be used when there is serious doubt concerning the stability of market or labor conditions that will exist during an extended period of Contract performance, and contingencies that would otherwise be included in the Contract price can be identified and covered separately in the Contract. Economic price adjustments are adjustments:

based on established prices of specific items or the Contract end items,
based on actual costs of labor or material that the Contractor actually experiences during Contract performance and
based on cost indexes of labor or material that are specifically identified in the Contract.

In establishing the base level from which adjustment will be made, one shall ensure that contingency allowances are not duplicated by inclusion in both the base price and the adjustment requested by the Contractor under economic price adjustment clause.

WHAT IS A LABOUR CONTRACT?
In this type of Contract, the Owner buys and supplies all the material required for the construction to the Labour Contractor and only uses his labour. The system of employing Contract labour is prevalent in most industries including Construction, involving skilled and semi skilled jobs. A workman is deemed to be employed as Contract Labour when he is hired in connection with the work by or through a Contractor. Contract workmen are indirect employees; persons who are hired, supervised and remunerated by a Contractor who, in turn, iscompensated by the Owner of the site. Contract labour has to be employed for work which is specific and for definite duration.

WHAT ARE THE ADVANTAGES OF A LABOUR CONTRACT?

This kind of Contract is sometimes preferred by the Owner, because he buys all the material by himself and thus saves a lot on the Contractor’s profit.
Moreover, the Owner can buy the materials of his choice and can be sure of the brand that will be used in the construction.

WHAT ARE THE DISADVANTAGES OF A LABOUR CONTRACT?
However, I personally would discourage a Client from entering into this type of Contract for the following reasons:

In this Contract also, the Architect does not have a role to play, and so quality of work cannot be checked and controlled by an expert.
There is a lot of headache and tension involved in running around and arranging for the supply of materials at site, on time as the work progresses.
It is easy to get fooled on the quality of sand, bricks etc because the Owner is not very experienced in assessing the quality.
It is difficult to strike a good bargain when negotiating with suppliers and vendors, because the Owner is a one time Client, wheras the Contrctor normally has an advantage as he is a regular Client and a relationship is built between him and the suppliers.
There is every possibility of pilferage of the material stored at site.
Very often labourers, masons etc do not turn up to site as they may be lured for a day to some other site and hence the work gets delayed.
Since the workers are generally paid for the work on a daily basis, the labour Contractor may purposely go slow so that he he takes longer to complete the job and so get paid more.
Inferior labour status, casual nature of employment, lack of job security and poor economic conditions are the major characteristics of Contract labour. While economic factors like cost effectiveness may justify system of Contract labour, considerations of social justice call for its abolition or regulation.
In fact, in my experience, I have seen that in most cases, the Owner ends up spending almost as much, at the end of the project as he would have if he had chosen any other type of Contract.

WHAT IS A COST + CONTRACT?
This type of Contract is not popular in India. This is a Contract agreement wherein the Owner agrees to pay the cost of all labor and materials plus an amount for Contractor overhead and profit (usually as a percentage of the labor and material cost). It is like a Labour Contract, but here the Contractor buys the materials and provides the labour and is reimbursed accordingly. This type of Contract is favored where the scope of the work is indeterminate or highly uncertain and the kinds of labor, material and equipment needed are also uncertain. Under this arrangement complete records of all time and materials spent by the Contractor on the work must be maintained.
This type of Contract can be altered according to the basis on which the additional amount paid to the Contractor is fixed.

COST + FIXED % CONTRACT- It is based on a percentage of the cost
COST + FIXED FEE CONTRACT – It is based on a fixed sum independent of the final project cost.
COST + FIXED FEE BONUS CONTRACT –It is based on a fixed sum of money and a bonus is given if the project finishes below budget, ahead of schedule etc.
COST + FIXED FEE WITH SHARING ANY COST SAVINGS CONTRACT- It is based on a fixed sum of money and any cost savings are shared with the Owner and the Contractor.
INCENTIVE CONTRACTS – It is based on the Contractor’s performance on the agreed target – budget, schedule and/or quality.

WHAT ARE THE ADVANTAGES OF THE COST + CONTRACT?

It has the advantages of the Labour Contracts.
In addition, since the Contractor gets an additional amount at the end of the project, it provides maximum incentive for the Contractor to control costs and perform effectively and on schedule.

WHAT ARE THE DISADVANTAGES OF COST + CONTRACT?

In this Contract also, the Architect does not have a role to play, and so quality of work cannot be checked and controlled by an expert.
Since the Contractor is reimbursed based on the records of the workers he has employed and the materials he has bought, one can never be sure if these records are genuine, as there is no way of verifying them. So, this type of Contract is rarely adopted in India.

WHAT IS A PROJECT MANAGEMENT CONTRACT?
Project Management Contracts are a type of Contract where the Architect agrees to manage the Contract, as defined by the scope of the agreement, for a specified duration of time for monetary consideration. This type of Contract can be short term or long term.

WHAT ARE THE ADVANTAGES OF PROJECT MANAGEMENT?

The Clients can focus on their core operations while the Architect (Project Manager) looks after the management of Projects, people and issues, ensuring that deadlines are met, quality is maintained and costs are controlled.
The Project Manager coordinates with all the agencies, including the Consultants, the Contractor and the Suppliers to ensure that the construction of the project goes on smoothly.

WHAT ARE THE DISADVANTAGES OF PROJECT MANAGEMENT?

Some Clients hesitate to go in for Project Management Contract as they have to pay extra for project management, in addition to the fees paid to the Architect. However, there are lots of Clients nowadays, who opt for Project management as it saves them from a lot of headache and they can concenterate on their work as the building comes up. Moreover, in the long run, since the project is completed on time, and costs are controlled, the Client actually saves.

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