What is a contract and why are contracts needed?
The promoter rarely is in a position to undertake the execution of the engineering works required in a project. External party, exerienced in the type of work required is brought in.
- The relationship between the promoter and the external party is a contract. An engineering contract is a mutual agreement with two parties.
- The external party is the contractor and agrees to undertake the work required in return for payment.
- The promoter becomes the principal of the contract and will make the payments.
- The process is called contracting.
How does the contract negotiations look like?
The principal commences negotiations (an invitation to tender is proposed).
Contractors, if they decide to tender, will respond to the invitation. Their tender is their final offer, and usually there are offers from more than one contractor.
On receipt and evaluation the Principal will accept, reject or make a counter offer.
On receipt of the counteroffer the contractor either accepts or submits another offer.
This continues until the two parties reach an agreement.
What is an “Instrument of Agreement”?
The contract must be evidenced to ensure the negotiated agreement is enforceable in law. This evidence and terms and conditions of the contract are usually set down in an instrument of Agreement.
There are two different formats of engineering contracts. What are these?
Formal contract:
- A deed which must be signed and witnessed and passed to the other party.
- Creates an estoppel.
Simple Contract:
- Not in any particular form.
- Requires consideration.
- Has a shorter limitation period.
Simple contracts requires consideration, what does this mean?
Consideration:
- An inducement to enter into a legally enforceable agreement and is the essential reason for a party entering into a contract.
- It can be either a detriment incurred by one party or a benefit received by the other party: it is the thing that is exchanged, no matter how minuscule.
- Thus, the party seeking to enforce the agreement must have paid, or promise to pay, some money, parted with some goods, or forgone some benefit.
A formal contract creates something called an estoppel. What is this?
A rule of law which prevents a party from later claiming that a statement expressed in the contract is incorrect, especially if others may have been led to rely or act upon that statement. Since simple contracts don’t have this it makes enforcement difficult.
What is a limitation period?
It is the time following a breach of contract in which the innocent party may take action on the other. (Longer for formal contracts).
There are four basic requirements to form a valid contract to demonstrate an “Intention to create legal relations”.
- Intention of the parties.
- Genuine consent of the parties.
- The purpose must be legal.
- Both parties must be legally capable.
Other than the four basic requirements to form a valid contract, simple contracts requires two further requirements. What are these?
Offer and acceptance:
- An unconditional acceptance by one party of an offer by an other forms a contract.
- Can be in writing, oral or implied by conduct.
Consideration:
- The money paid by the principal to the contractor and
- The work supplied by the contractor to the principal.
What is the biggest legal challenge for contracts of any type?
Establishing that a contract has been formed. (Look at Case Study 1)
What is an “instrument of agreement”.
- Signed by both parties without witnesses, the IofA is written evidence of a simple contract.
- If signed, sealed and delivered as a deed in the presence of witnesses, the IofA becomes formal.
- Parties to a simple contract may merge it to a formal contract by executing a formal IofA.
- Many Engineering Promoters require the parties to execute a formal IofA to ensure a formal contract exists.
What are the different types of contracts?
Main contracts are classified by:
- Method of selecting the Contractor. (Competitive tendering or Negotitated Contract).
- Method of payment for the work. (Price based or Cost based)
- Technical and Administrative Responsibility. (Seperate design and construction or Design and construct contract or Construction supply/ installation contract or Management contract (and variations) or Turnkey Contract.
What is Competitive Tendering?
- The principal formally invites a number of contractors to submit bids.
- Bids estimated using common tender documents.
- Principal assesses bids and either accepts a contractor’s bid or further negotiates an agreement.
- Usual method.
What is Negotiated Contract?
- Principal negotiates directly with contractor(s).
- No formal tendering process.
- Contract formed when mutual agreement reached.
- Used commonly when: Work of highly specialized nature, very few capable contractors and principal has good previous relationship with contractor.
However, a combination of competitive and negotiation can be used.
Method of payment for work can be divided into price based and cost based. These can further be divided into to categories. What are these?
Price based: Lump sum & Measure and Value
Cost based: Cost reimbursable & Target cost
One price based method of payment of work is called “Lump sum”. Explain this?
- Used if nature and extent of work can be precisely defined at tender stage.
- Contractor paid the amount stated in the contract, which is a figure agreed during negotiations.
- Usually paid at milestones in installments.
- Amount may be changed if extra work is added or work deleted after commencement.
- Unsuitable if change expected.
- Contractor bids likely to contain risk contingency sums.
The implication for lump sum are:
- Complete, final design at tender, so minimum change / variations expected.
- High degree of tender competition.
- Contractor plans efficient use of resources to reduce cost.
- Contractual mechanism for price adjustment.
- Unsuitable when change is expected.
- Price may include high level of financing by contractor for risk.
Describe the method of payment called “Measure and Value”.
- Also called admeasurement or remeasurement.
- Contractor bids rates for item of work.
- Final payment therefore depends on quantity of work done.
- Work is remeasured after it is done to determine payment.
- Bill of quantities method: Tender based on listed items of work with estimated quantities. (Provides tender total)
- Schedule of Rates method: Tender based on items of work with no quantities. (Nature of work can be defined; quantity cannot.)
Describe the method of payment called “Cost Reimbursement”.
- The contractor is paid actual costs plus a fee. This fee may be:
- A fixed sum.
- A fixed sum with a bonus scheme.
- A fixed fee with sliding scale adjustments.
- A percentage of the costs.
- Used when nature of work now known at tender stage.
- Can allow construction to proceed as design develops.
- High risk to principal but allows contractor design input.
Implications of Cost Reimbursement:
- Allows for early contractor involvement even in early design.
- Final cost to promoter depends on extent to which risks materialize.
- Efficiency of contractor will influence the cost to the promoter.
- Allows promoter participation in project management.
- Allows contractor to input to design.
Describe the method of payment called “Target Cost”.
- A profitable cost for the whole project is set, as agreed at contract negotiation.
- Contractor paid costs as with cost reimbursement contract (usually with a fee).
- Differences between actual and target cost are shared between promoter and contractor.
- The split of excess costs or cost savings is normally loaded to contractor to provide incentive.
- Usually different ratios for cost saving and target excesses.
Why should you go for Cost Reimbursement?
- In price based contracts, design needs to be quite well defined before tender/construction.
- If construction overlaps design, then alternative payment mechanism is needed.
What are the factors one has to consider when choosing which method of payment is going to be used??
- Degree of certainty about the final contract price desired at tender stage.
- Flexibility required to cope with design changes likely to be encountered during the contract.
- Contractors incentive for efficient performance, matched by the promoters incentive to provide the contractor with timely information and decisions.
- Extent of risk likely to be encountered during the contract and the most cost and time efficient way of allocating it.
For which method of payment does the risk for the contractor increase?
Contractor:
- Cost reimbursable.
- Target cost.
Promoter:
- Measure and value.
- Lump sum.
Because projects have widely differing inputs from technical, professional and administrative bodies, contracts can be classified according to the way these bodies are organised. What are these principle classifications?
- Separate design and construction.
- Design and construct contract.
- Construction supply / installation contract.
- Management contract.
- Construction management contract.
- Design and management contract.
- Turnkey contract.
What does Separate design and construction mean?
That there is no direct link between designer and contractor
