CE 411

Engineering Management

LECTURE 7
CONSTRUCTION CONTRACTS
 What is a Contract?
an agreement between two or more parties
which has a binding nature,(legally enforceable)

Defines the duties and obligations of parties

involved
 5 Elements of a contract to be valid
• 1.There is An offer

• 2.Acceptance of that offer;

• 3.There is intention to enter into a contract (both agreed)

• 4 .Clear terms and conditions (ex. construct project in 2 years)

• 5.Consideration (i.e. something in exchange such as money or

services.

If these 5 elements exist, whether in writing or not, you have a

contract.
 Examples of contracts made in
ancient times
Now in earlier times in
Israel, for the
redemption and transfer
of property to become
final, one party took off
his sandal and gave it to
the other. This was the
method of legalizing
transactions (contracts)
in Israel.)

• Ruth 4:7
 Marriage is an example of Contract

• 1.There is An offer

• 2.Acceptance of that offer;

• 3.There is intention to enter into a contract (both agreed)

• 4 .Clear terms and conditions (ex. construct project in 2

years)

• 5.Consideration (i.e. something in exchange such as money

or services.
Why Is Construction Contract Necessary?
• protect both parties in agreement in case of
disputes
• detail type, schedule and cost of work
• outline methods of communication
• Show how disputes are handled
• fast decision-making.
• Anticipate project risk
(natural calamities, price increase, accidents , company bancruptcy)
 Contract Components

1. General conditions
(description of project)
2. Special conditions (if any)
3. Drawings and
specifications
4. B.O.Q (bill of quantity)
5. Letter of acceptance by
contractor
6. Contractor bid
 (Continued) Contract components
7. Rights and responsibilities of owner and
contractor

8. Project schedule (Gantt chart/ PERT CPM)

9. Payment method

10. Warranty and delay penalty

 Bill of Quantities (BoQ)
• a list of all the materials and labor
etc that will be required for your
desired build.

• It’s often put together before a

construction contractor has been
hired and

• is a guiding document for those

companies that are bidding for the
work (Total Cost of project)

• Prepared by a Quantity Surveyor (QS)

who is also a civil engineer
 Variation Order (VO) in a Contract
• refers to any increase/decrease in quantities within
the general scope of the project as bid and awarded,

1. Introduction of new work items that are not included in the

original contract; or

2. Reclassification of work items due to change of plans,

design or alignment to suit actual field conditions

3. After awarding of contract to contractor, There is a

disparity between the preconstruction plans used for
purposes of the bidding and the actual “as staked plans”
or construction drawings
Sample
 Two types of variation Order
• Change Order
• Extra Work Order
•
A Change Order covers any increase/decrease in quantities of
original work of items in the contract.

An Extra Work Order covers the introduction of new work necessary

for the completion/improvement or protection of the project which
are not included as items of work in the original contract.
 Note that in V.O.s
• The addition/deletion of works
should be within the general
scope of the project as bid and
awarded, and the deletion of the
work should not affect the
integrity and usefulness of the
structure.
• How much Variation Order is allowed?

The net cumulative amount of the

Variation Order should not exceed positive
ten percent (+10%) of the original project
cost.

• Otherwise, a new contract must be

proposed between owner and Contractor
 Note
• If the adjustments provided for in a
Variation Order costs more than ten
percent (10%) of the original project costs,
these shall be the subjects of another
contract to be bid out if the works are
separable from the original contrac
Types of Construction
Contracts
 1.Lump-sum contract
( fixed price contract)

• The traditional form of construction contract (Pakyaw)

• Contractor names a total fixed price

for entire job.

• Materials
• Labor
• Equipment
• Miscellaneous (overhead cost/ day to day construction
cost like water , electricity water, xerox etc)
 Features of lump sum contract
Contractors charge an additional
percentage (mark up) for signing lump sum
contracts for their PROFIT 8-15%)

• there is a higher risk of failure if cost is not

calculated properly by the QS
 Advantages of lump sum

1 May lead to higher profit margins.

2 Easily compare bids.

33. Incentive programs are placed by

owners to reward jobs completed
early.
 Disadvantages of lump sum
• contractors may wish to downgrade quality of
work in order to increase their profit margin.

• If lump sum is poorly managed, contractor

profit margin can disappear.
 2.Unit Price Contract
• Sets a fixed price for a distinct, repeating
aspect of a project(called a unit, e.g. highway
or road construction)

helpful for situations where:

• Number of units of work is uncertain(length
of road is not certain)
• duration is uncertain(time to complete is
uncertain)
 Example Scenario of Unit Price
Contract
• A contractor building 10 km of highway may sign
a unit price contract,

• with each mile of highway representing a unit.

• The same labor and materials will be used for

each mile of road,

• so the contractor bills for each of those units at a

fixed price.
 Advantages of unit price
 1.Simple tracking and billing

 2. good type of contract for projects with

 unknown duration and

uncertain number of “work units”

 Disadvantages of unit price
• 1.Poor or wrong pricing can sink contractors

• 2.Owner does not know total cost.

And total number of work units required
3.Time and Materials (T&M ) contract
T&M contracts pay or reimburse contractors for:

• all construction cost (direct construction costs materials labor,

contractor , equipment )

• All indirect costs (admin fee and overhead)

• fixed daily /hourly wage for labor costs.

• NOTE

(unlike in type 1 and 2 contractor decides hourly wage)

Fixed wages of workers therefore no injustice on part of workers
 Owner pay the GC
(gen. contractor )with the following
• 1.Materials costs

• 2.Labor costs/ daily worker pay,

• 3.overhead (day to day operation, rent, gas, water,

electricity , office supplies.,etc)

• 4.administrative costs( HR, accounting etc)

• 5. profit margin(percentage as per contract 8-15%)

 advantages
1. risk for general contractors are less

Because the owner pays for actual costs, the

GC(general contractor) can focus on managing
possible delays and changes.

2.Profit of contractors can be predictable.

3.Fixed wages of workers

 Disadvantages
• Increases risk for owners.
owners may face unknown high costs.(cement
steel , wages etc)

• Tracking for costs for materials and labor

wages can be challenging for contractor
(labor hours and material costs reports
 4. Cost Plus Construction Contract
• Is used when project needs to start immediately

• Final design and plan details are not yet

completed

• when the scope of work and duration of work is

still unclear during planning stage

• difficult to estimate the total cost.

Pile foundation work in bridge construction is an example
of a project with non finalized design resulting in unknown
project duration and uncertain scope of work
 Note
• Length and diameter of piles is dependent on
VARIABLE soil condition below

• Thus cost plus contract is preferred

 What is covered in cost plus contract?

Direct costs of project,

Project Costs
including labor, materials, subcontractor , equipment
(direct Cost) consultancy , expenses, allowances, and change
orders (CO)

Contractor
a percentage of the total project cost or
Markup cost
a fixed fee that accounts for the general
(overhead cost and contractor’s overhead and profit (8-15%)
profit)
 Cost plus contract
Blls will be submitted by Contractor to
owner at
25%,
50%
75% and
100% completion of project.
 Advantages of Cost Plus contract
• Less risk to contractors of having to absorb
unanticipated costs. owner is responsible for
every cost of the project.

• Emphasizes quality of work and meeting

performance goals rather than cost-cutting.

• Assured payment to contractors even if

project still has unclear scope of work
 Disadvantages of Cost Plus
• final cost of the project is not fixed.

• Owner pays for materials price increase

• Without regular monitoring, costs can quickly

escalate for the owner

• . Total price of cost-plus contract may be higher

than other contract types(due to unclear scope)

• In cases of cost overrun, the contractor requires to

show a lot of additional evidence to justify the
increase in the cost of the project.
 5.Project Management Agreement

• Principal(owner) does NOT contract directly

with Contractor

• Owner Contracts with his (Project Manager

PM ) NOT with a Contractor

• The PM is now directly responsible to the

Owner , not the contractor
 Advantages
• Owner coordinates primarily only only one
person ,the Construction Project
manager(CPM_)

• Accountability rest on one person , the CPM

 Disadvantages
• Project Manager, has more extensive
responsibility than those performed by the
GC or gen . Contractor

• CPM faced with great challenge and

accountability to the owner

• Owner / CPM professional relationship must

remain strong
 6. Design-build contracts
• a design-build contract only one
company is responsible for the
designing and building for a project.

• Design work and construction work

is done by one company
 Design Build Contracts advantages :

• save time and money

• Has Unified project recommendations
• Has Collaborative problem solving
• No blame-shifting between designer and
contractor
• prevent owner - contractor and
designer disputes
 Disadvantages of Design
Build Contract
• Design are less creative than from
independent designer.

• Lack of true competitive bidding .

• Contract Depends on trust in contractor.

 7.Build Own Operate Transfer (BOOT)
1.Private Contractor (ex. SMC) builds/finances a
project of the owner (govt)

2. Temporarily owns the project for a fixed period and

creates business opportunities for the project
(makes money)

3.transfer the project to the owner at end of project

• Typically, employed on public infrastructure

projects (e.g.highway with toll fees, NLEX , SLEX ,LRT,
MRT)
 Advantages of BOOT contract
• Advantageous for very large complex
projects(ex. NLEX, SLEX, expressways)

• Govt public-sector funds may be used for other

important infrastructure projects (irrigation,
housing, sanitation , health etc)

• Reduces Government Debt (privATE contractor

assumes debt)
 Disadvantages of the BOOT
• It only works for large projects.

• It requires fund-raising by private company to

be successful.

• It can have higher payment transaction costs

for people .(LRT ticket , NLEX tolls,etc)
 8.Incentive Construction Contracts
(Extra Payment )
• project owner and contractor agree on an
extra payment fee (incentive)

• given to the contractor if the project is

delivered on time and under budget.
 continued
• If the contractor misses the timeline or
exceeds the budget……. Then……

• they still need to complete the project and

even without earning the extra payment fee.
Advantages of Incentive Construction
Contracts
• Construction Innovation by contractors is enhanced

• High accountability on contractors doing the work

(due to the incentive)

• skill of personnel is developed

• promotes better lines of communication during the

project between owner , CPM and contractors
 Disadvantages
• disputes may occur between owner and
contractor

• priority of the contract (may become the

incentive pay)

• creates additional administrative costs for

owner

• Difficult to determine what a fair incentive is

• End of lecture 3