Week 6

Question 1

What is a contract and why are contracts needed?

Answer 1

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.

Question 2

How does the contract negotiations look like?

Answer 2

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.

Question 3

What is an “Instrument of Agreement”?

Answer 3

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.

Question 4

There are two different formats of engineering contracts. What are these?

Answer 4

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.

Question 5

Simple contracts requires consideration, what does this mean?

Answer 5

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.

Question 6

A formal contract creates something called an estoppel. What is this?

Answer 6

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.

Question 7

What is a limitation period?

Answer 7

It is the time following a breach of contract in which the innocent party may take action on the other. (Longer for formal contracts).

Question 8

There are four basic requirements to form a valid contract to demonstrate an “Intention to create legal relations”.

Answer 8

• Intention of the parties.
• Genuine consent of the parties.
• The purpose must be legal.
• Both parties must be legally capable.

Question 9

Other than the four basic requirements to form a valid contract, simple contracts requires two further requirements. What are these?

Answer 9

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.

Question 10

What is the biggest legal challenge for contracts of any type?

Answer 10

Establishing that a contract has been formed. (Look at Case Study 1)

Question 11

What is an “instrument of agreement”.

Answer 11

• 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.

Question 12

What are the different types of contracts?

Answer 12

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.

Question 13

What is Competitive Tendering?

Answer 13

• 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.

Question 14

What is Negotiated Contract?

Answer 14

• 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.

Question 15

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?

Answer 15

Price based: Lump sum & Measure and Value

Cost based: Cost reimbursable & Target cost

Question 16

One price based method of payment of work is called “Lump sum”. Explain this?

Answer 16

• 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.

Question 17

Describe the method of payment called “Measure and Value”.

Answer 17

• 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.)

Question 18

Describe the method of payment called “Cost Reimbursement”.

Answer 18

• 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.

Question 19

Describe the method of payment called “Target Cost”.

Answer 19

• 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.

Question 20

Why should you go for Cost Reimbursement?

Answer 20

• In price based contracts, design needs to be quite well defined before tender/construction.
• If construction overlaps design, then alternative payment mechanism is needed.

Question 21

What are the factors one has to consider when choosing which method of payment is going to be used??

Answer 21

• 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.

Question 22

For which method of payment does the risk for the contractor increase?

Answer 22

Contractor:

• Cost reimbursable.
• Target cost.

Promoter:

• Measure and value.
• Lump sum.

Question 23

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?

Answer 23

• Separate design and construction.
• Design and construct contract.
• Construction supply / installation contract.
• Management contract.
• Construction management contract.
• Design and management contract.
• Turnkey contract.

Question 24

What does Separate design and construction mean?

Answer 24

That there is no direct link between designer and contractor

Question 25

What does Design and construct contract mean?

Answer 25

Promoter wished design to be tendered and managed by the contractor.

Question 26

What does Construction supply / installation contract mean?

Answer 26

Industrial projects: installation and commissioning of plant also required under contract.

Question 27

What does Management contract mean?

Answer 27

• Appointed by the promoter to manage all construction aspects and sometimes design.
• Does not carry out construction: enters into separate contracts with construction contractors.
• Paid a fee.

Question 28

What does Construction management contract mean?

Answer 28

• The construction manager is a contractor with very similar duties to the management contractor.
• Main difference: Contracts placed with promoter.

Question 29

What does Design and management contract mean?

Answer 29

• Very similar to management contracting.
• Design direct responsibility of the contractor.
• Similar to Design and construct with emphasis on management of the project.

Question 30

What does Turnkey contract mean?

Answer 30

• A scope/outline design provided by promoter’s designer.
• Thereafter, all design, procurement, construction, commissioning and sometimes operation managed by one company.

From exam:
It is a contract in which the Contractor assumes complete responsibility for the project and, in effect becomes the Promoter. The Contractor undertakes detailed design procurement and construction. A scope design is prepared by a separate designer.
In most cases the Contractor will not undertake the whole of the work for a major project entirely from within the Contractor’s own resources. The contractor usually divides the work. Although such a procedure is at the Contractor’s option, it is usual for the Contract to require the promoter to approve any such subcontract agreements when they are proposed. Notwithstanding the approval of the subcontractor by the Principal, the Main Contractor is entirely responsible for subcontractor supervision and seeing that the subcontractor undertake the work under the subcontract and fulfills the terms of the main contract.
Points to consider:
- There is a single point of contact for the promoter.
- Management of design and construction is integrated.
- Specification must be defined early in the design phase.
- Time is saved from the design/construction overlap.
- The likelihood of better design buildability is enhanced.
- Payment may be staged lump sums or BoQ.
- Post contract the promoter’s negotiating position is generally weak.
- The extent of, and methods for, checking the contractor’s design can be contentious.

Question 31

When evaluating tenders, it might be tempting to consider very low bids. However, these should be considered very carefully. Why?

Answer 31

When you pay too much all you lose is a little money. When you pay too little you sometimes lose everything because the thing you bought was incapable of doing the thing it was bought to do.
If you deal with the lowest bidder, it is well to add something for the risk you run, and if you do that, you will have enough to pay for something better.