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CONTRACTS MANAGEMENT ASSESSMENT OF RISKS WHILE 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

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

be

encountered if the bid is selected and contract awarded

contractual situation

will

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?

Will

the

contract

be

fair,

will

it

or

Owner-Construction Contractor Prime Contract “Red Flag” Clauses

Old

contract

until you have read and understood every single word”

adage:

“Do

not

sign

a

Not possible in most cases.

time

consuming and expensive “Do not undertake a cost estimate and start bid preparation until you have read and understood the potential contract”

Preparation

of

cost

estimate

Carefully examine and understand the provisions of certain key contract clauses “red flag” clauses.

Important “Red Flag” Clauses

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

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

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:

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

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:

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

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

fabricated products

of

materials

and

Retained percentage provision

Mobilisation advance

Interest on delayed payments

Final Payment

impact the

contractor’s cash flow and consequently the cost of carrying out the work

All

the

above

will

Important “Red Flag” Clauses

Measurement

provisions

and

payment

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

Usually found in the specifications

Procedures

recording

measurements and levels of checking before certification and payment

for

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.

Vary from being even-handed to being grossly unfair

Important “Red Flag” Clauses

Variation in quantities

Important in Item rate contracts where estimated quantities are large and can potentially underrun or overrun.

Rates quoted by the contractors contain two components

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

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

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 Changes in Legislation could involve

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 “no- damages-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.

What are the contractual relief/ compensation in case of Termination / Partial terminations??

Additional “Red Flag” Clauses

Dispute

Law Clause

Resolution

and

Governing

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).

Additional “Red Flag” Clauses

Dispute Resolution and Governing Law Clause

Means for dispute resolution

Submittal to an administrative

board

involved

of

the

owner-agency

specially

Submittal

to

a

appointed

review board

contract

disputes

Arbitration

Formal trial in a court of law

Important “Red Flag” Clauses

Insurance and bond provisions

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

Cost

Whether the contractor will be able to obtain the bonds at all?

Bid

and

bond,

performance

bond,

and

labour

materials bond

Important “Red Flag” Clauses

Reports on physical site conditions

Especially

crucial

in

projects

involving

underground construction

Exculpatory clauses or disclaimers

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?

Typical Contract Wordings

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

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

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

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

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-in-

Charge 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 Engineer- in-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.

Typical Contract Wordings

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

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

the

right

alterations

reserves

to

, 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

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.

SAMPLE CALCULATION FOR IMPACT OF RISK FACTORS

All figures in Rs. Lakhs

Sl.

Risk Factor

Likely cost

Probability (P) ( 0 to 1)

Cost to be added (C X P)

Remarks

No

Impact (C)

1

Less Contract Duration ( Overtime / Acceleration/ Expedition expenses)

25.0

1

25.0

 

2

Liquidated Damages 5000 per day X 60 days

3.0

0.8

2.4

 

3

Price Escalation

10.0

0.9

9.0

 

4

OH during extended contract period ( 5 lakh per month for 3 months)

15.0

1

15.0

 

5

Changes in Taxes & Duties

10.0

0.5

5.0

 

6

TOTAL