12. Types and Classification of Engineering Contract

Question 1

What can contracts for any engineering project be classified as in the first instance?

Answer 1

Contracts Contracts for any particular engineering project can be classified in the first instance as either Main Contracts or as Subcontracts. The essential difference is that a Main Contract is directly between the principal and a Main Contractor, whereas a Subcontract is between a Main Contractor and another contractor, referred to as a Subcontractor.

Question 2

What are the three most commonly used classification that depend on a particular feature?

Answer 2

A. the method by which the Contractor is selected;
B. the method by which payment for the work under the Contract is evaluated;
C. the method by which responsibility for the technical and administrative aspects of the work is allocated.

Question 3

What is meant by ‘classification by the method of selection the contractor’ and explain both options?

Answer 3

The principal has two options when selecting the Contractor:

> by a competitive tendering procedure - an agreement is reached between the Principal and a Contractor following a formal competitive tendering procedure in which a number of tenderers are invited to submit bids against a common set of tender enquiry documents (see section 0). This is the most widely used form of engineering contract and is suitable for engineering projects where the nature and extent of the work under the Contract can be clearly identified.

> by direct negotiation with a selected contractor - the principal negotiates directly with a contractor to arrive at a mutually satisfactory agreement to undertake the work. This form of contract is suitable for work of a highly specialised nature or where there are a limited number of contractors experienced in the work required or where the nature of the work cannot be precisely defined. A contract can sometimes be negotiated by a combination of these methods. For example, tenders can be invited from a shortlist of suitable contractors for that part of the work under the contract, which can be precisely defined, and an agreement negotiated for the whole of the work with the contractor who submits the most attractive offer.

Question 4

What is meant by the term ‘method of payment for work’ and what are the main choices?

Answer 4

The method of payment is of such importance, particularly to the Contractor, that contracts are often classified solely by the method of payment. Payment can be based either on prices (which are submitted by or agreed with the contractor as what he will be paid) or on the actual costs that the contractor incurs.
Main choices are:
• Price Based: Lump Sum or Measure and Value (i.e. Schedule of Rates or Bill of Quantities).
• Cost Based: Cost Reimbursable or Target Cost

Question 5

What are the main factors that influence the method of payment of work?

Answer 5

:>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 (can they be systematically and equitably evaluated).
>contractor’s incentive for efficient performance, matched by the promoter’s 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 6

What is meant by the payment term ‘lumpsum’?

Answer 6

Also known as a Stipulated Price Contract. The Contractor is paid the amount nominated in the Contract for the work as agreed with the Principal when negotiating the Contract. This amount may of course, be increased or decreased owing to additions to or deletions from the scope of the work under the Contract in accordance with the terms of the agreement. This type of contract is commonly used where the nature and extent of the work can be precisely defined when the Contract is negotiated. Payments may be staged at intervals of time or related to achieved milestones.

Question 7

What are the implications of the lumpsum payment method?

Answer 7

> complete, final design at tender, so minimum change / variations expected.
high degree of tender competition.
contractor plans efficient use of resources to reduce cost.
no contractual mechanism for price adjustment.
unsuitable when change is expected, therefore rarely used in engineering construction.
price may include high level of financing by contractor and includes risk contingency - likely to be high.

Question 8

What is meant by the payment term ‘measure and value’?

Answer 8

The Contractor is paid for the work actually done at pre-agreed unit rates. In this type of contract it is important that the items in a Schedule of Rates or the Priced Bill of Quantities cover the whole of the work and that the method of measurement of quantities is clearly defined. Schedule of Rates Contracts are generally used where the nature and extent of the work can be accurately defined but the quantity of work cannot.

Question 9

What is the definition and purpose of a Bill of Quantities?

Answer 9

Used where items of work are listed with estimated quantities. In UK building and civil engineering, standardised item descriptions and limits to the work included in the item have been drawn up in ‘Standard Methods of Measurement’. Contractors then tender rates against each item. Payment is usually monthly and is derived from measuring quantities of completed work and valuing at rates in the priced Bill of Quantities.
It can be seen therefore that Bills of Quantities have two purposes:
• To provide a basis for the build up of a contractor’s tender estimate and thus to allow tender totals to be compared between bidding contractors; and
• To provide the basis for payment to the contractor once the contract has been awarded.

Question 10

What is a schedule of rates?

Answer 10

Schedule of Rates Used where prices are tendered against unit – rather than total – quantities, i.e. the overall quantity of work is unknown at tender stage. This provides an increased risk to the contractor.
The implications of this are:
• design may be only partially complete at tender.
• final price invariably different from Tender Total - due to change and delay - which produces claims.
• high degree of tender competition, but uncertainty as to whether the lowest tenderer will yield the lowest final price.
• variations must be provided for with procedure for their evaluation.
• magnitude of contractor financing depends on disparities between costs and revenues.
• price includes risk contingency.

Question 11

What is meant by the payment term ‘cost reimbursement’ and its main use?

Answer 11

The Contractor is reimbursed the actual costs incurred in carrying out the work under the Contract plus a fee to cover overhead costs and profit. The fee can be one of the following:
• a fixed sum.
• a fixed sum with a profit-sharing or a bonus arrangement.
• a fixed fee with a sliding-scale adjustment.
• a percentage of the costs.
A cost reimbursement contract may also have a guaranteed ceiling price nominated. The main use for a cost reimbursement contract is where the nature, extent or quantity of the work cannot be accurately defined when negotiating the Contract. It requires the contractor’s cost accounts to be open to the promoter.

Question 12

What is meant by the payment term ‘target cost’?

Answer 12

Based on the setting of a probable (or target) cost for the work. The target cost will subsequently be adjusted for major changes in the work and cost inflation. The contractor’s actual costs are monitored and reimbursed as in a cost-reimbursable contract. Any difference between actual cost and target cost is shared in a specified way between the promoter and the contractor. The sharing is usually set as a percentage ratio e.g. 80:20 with different allocation for savings and excess costs. Both promoter and contractor must be satisfied with the target estimate that should have a reasonable maximum and minimum cost for the work. Usually, as with cost reimbursement, there is a separate Fee for overheads and profit.

Question 13

What are the incentive provisions for each payment method?

Answer 13

A cost reimbursement contract on a target cost basis automatically includes an incentive for the contractor to reduce costs. For price based contracts such an incentive is already there: if the contractor reduces costs the margin between cost and price is automatically increased. However, any of the payment methods can have some form of additional incentive provisions attached to them. In addition, incentives can relate to criteria other than cost. For example, bonuses may be awarded for early completion (or indeed penalties incurred for late completion).

Question 14

What is meant by ‘classification by technical and administrative responsibility’?

Answer 14

The implementation of an engineering project involves a number of separate tasks, the responsibility for which must be established clearly from the outset:
• project management and co-ordination;
• engineering design: conceptual, process, detailed (if applicable), documentation
• procurement and supervision;
• construction and supply and/or installation;
• contract administration.

Question 15

List the 7 classifications under ‘Technical and Administrative Responsibility’

Answer 15

i. separate design and construction;
ii. design and construct contract;
iii. construction supply / installation contract;
iv. management contract;
v. construction management contract;
vi. design and management contract;
vii. turnkey contract.

Question 16

What is meant by the classification ‘separate design and construction’?

Answer 16

Here, the consulting engineer (or promoter’s inhouse engineering team) is responsible for design and the contractor for construction. The consulting engineer is thereafter known as the Engineer and is responsible for supervision of construction and, also, for administration of the construction contract. The Engineer thus has a ‘dual role’ with potentially split loyalties.

Question 17

What are the implications of separate design and construction?

Answer 17

• familiarity with the approach has led to widespread use;
• the most appropriate and experienced designers can be selected;
• normally used with measure and value (i.e. uses BoQ);
• the design is usually complete before tender;
• management is divided between the parties;
• the use of this approach with traditional model forms of contract tends to lead to frequent disputes over claims.

Question 18

What is meant by the classification ‘design and construct contracts’?

Answer 18

The promoter may wish for the detailed design as well as the construction to be put out to tender. In such cases he must appoint his own engineer to provide information on the scope of the project through outline designs, design criteria and performance requirements. This information is supplied to the tendering contractors who will submit enough details for the promoter to appraise the contractor’s proposals and prices. The contractor need not necessarily at such a stage submit detailed drawings. It is unusual for a contractor to carry out design ‘in-house’ even though most big companies have their own design departments. A design and construct contract usually involves the same types of parties as a traditional contract except that the relationships between them are slightly different.

Question 19

What is meant by the classification ‘design and construct contracts’?

Answer 19

The promoter may wish for the detailed design as well as the construction to be put out to tender. In such cases he must appoint his own engineer to provide information on the scope of the project through outline designs, design criteria and performance requirements. This information is supplied to the tendering contractors who will submit enough details for the promoter to appraise the contractor’s proposals and prices. The contractor need not necessarily at such a stage submit detailed drawings. It is unusual for a contractor to carry out design ‘in-house’ even though most big companies have their own design departments. A design and construct contract usually involves the same types of parties as a traditional contract except that the relationships between them are slightly different.

Question 20

What is meant by the classification ‘construction supply/installation contract’?

Answer 20

In this type of contract it is the Contractor’s responsibility to carry out the work under the Contract in accordance with designs, specifications and other details provided by the Principal. In some cases, such as in process and industrial projects, the Contractor may be required to undertake all or part of the design. The principal is responsible for all the other tasks; these may be carried out on the Principal’s behalf by one or more specialist consultants.

Question 21

What is meant by the classification ‘the management contract’?

Answer 21

The management contractor is appointed to manage the design and construction phases and contribute to the design itself. Such a contractor is normally precluded from carrying out construction, although they may provide common facilities. The management contractor becomes part of the promoter’s professional team, and construction contracts are placed with the management contractor.

Question 22

What are the implications of a management contract?

Answer 22

• payment of the management contractor is by fee, sometimes plus reimbursable costs.
• the promoter – through the management contractor – pays the construction contractors.
• construction is usually broken into small packages with designs complete with high competition at tender.
• designers must make more decisions early in the design than with separate design and construction.
• since the management contract itself is low risk the promoter carries more risk, offset by the high level of management control.
• some management contractors carry normal construction risks.

Question 23

What is meant by the classification ‘the construction management contract’?

Answer 23

The construction management contractor carries similar responsibilities to the management contractor. The important difference is that construction contracts are placed directly with the promoter. The construction management contract is similar to the conventional approach of separate design and construction except that the management responsibility is separately identified and likely to be more rigorously defined and executed.

Question 24

What are the differences between the management contract and the construction management contract?

Answer 24

• the construction management firm need not be a construction contractor;
• construction contracts can carry the normal risk required by the promoter;
• the construction management firm has no commercial professional conflict of interest;
• the construction manager is treated as a professional service provider and is paid a fee accordingly.

Question 25

What is meant by the classification ‘the design and management contract’?

Answer 25

This is a version of management contracting in which the detailed design is the direct responsibility of the design and management contractor. It differs from Design and Build in that payment is similar to the management contract, the promoter has greater control (e.g. over sub-contract content and sequence) and is less committed to the whole technical package.

Question 26

What are the similarities between the design and management contract and the design and construct contract?

Answer 26

• 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 overlaps.
• the likelihood of better design buildability is enhanced.

Question 27

What is meant by the classification ‘the turnkey contract’ and what are the points to consider?

Answer 27

The contractor undertakes detailed design, procurement and construction. A scope design is prepared by a separate designer. It is a contract in which the Contractor assumes complete responsibility for the project and, in effect becomes the Promoter.
Points to consider:
• payment may be staged lump sums or BoQ.
• a clear and full specification must be drawn up early in the design stage.
• post contract the promoter’s negotiating position is generally weak.
• arrangements may be needed to cover the cost of design done by the contractor in the tender period.
• the extent of, and methods for, checking the contractor’s design can be contentious.
• the promoter’s commissioning requirements must be written into the contract.

Question 28

List the three types of subcontractor.

Answer 28

1. Designated Subcontractor
2. Selected Subcontractor
3. Nominated Subcontractor

Question 29

What is meant by a designated subcontractor?

Answer 29

Highlighted by the promoter/principle before tender to carry out certain work or to supply certain items or services. The nature and extent of these are clearly described in the tender documents and the Contractor can be reasonably expected to price and allow for at the time of tendering. It is up to the Contractor to negotiate with the designated subcontractor before submitting the tender. As the Contractor knows right from the beginning who the Subcontractor is, there can be no right of objection to the designation once an agreement has been reached with the principal. The principal usually accepts responsibility for default by a Designated Subcontractor.

Question 30

What is meant by a selected subcontractor?

Answer 30

Selected by the Contractor from a restricted list of approved subcontractors supplied by the principle. As long as the work is carried out by one of the selected subcontractors on the list, the principal must approve the subcontractor. As with a Designated Subcontractor, the Main Contractor must negotiate with the subcontractor. In the event of a Selected Subcontractor defaulting, it is usually the Main Contractor’s responsibility to negotiate with one of the other subcontractors on the list to complete the work.

Question 31

What is meant by a nominated subcontractor?

Answer 31

Selected by the Principal without reference to the Main Contractor. As a general rule, a Provisional Sum in the Contract covers the work carried out by a Nominated Subcontractor. Frequently, the Principal independently invites tenders for the work under the subcontract, and directs the Main Contractor to enter into a subcontract with the Nominated Subcontractor selected on terms and conditions negotiated by the Principal. As with Designated Subcontractors, the principal accepts responsibility for nominating a new subcontractor in the event of the Nominated Subcontractor defaulting and is liable for any resulting costs.