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GanzRecht > Studium & Lehre > Ausland > Const. Contracts & Arbitration




Types of construction contracts

von Holger Langer, LL.M.

A. Factors influencing the choice of contract

  • necessary to ascertain in advance that the proposed project would be
    • technically feasible
    • economically viable
    • financially supportable
    • operationally resourceable
  • three main components that govern the choice
    • to whom is the essential function of finance in the contract allocated?
    • to whom are the functions of design and construction allocated?
    • to whom are the risks allocated (esp. quality control and valuation)?

I. Allocation of finance

  • construction projects can be financed in a number of ways
    • self financing (balance sheet financing) through the owner’s own resources
    • borrowing from a lending agency
    • financing through involvement of the public and / or the Contractor of the project (classic project finance, PPP / PFI, BOT etc.)
  • BOT / BOOT
    • requires the presence of three elements
      • feasible and viable project
      • willing government to grant a concession agreement which empowers the concessionaire the right to operate and benefit from the project
      • sponsors who are willing to take the financial risk of undertaking the project
    • however, traditional methods until recently widespread, i.e. use of fiscal resources or sovereign borrowings from lending agencies (World Bank, IMF, African Development Bank etc.)
    • recently becoming more popular
      • major global shortcomings in funding since the need for infrastructure grows
      • involvement of public directly rather than imposing higher taxes
      • encouraged by the economic growth of many countries around the world (e.g. per capita income) which permits the participation of the general public in projects for the benefit of the whole society

II. Allocation of design and construction

  • basically distinguish between FIDIC Red Book, Yellow Book and Silver Book
    • Red book:         design by Employer (Engineer), construction by Contractor
    • Yellow / Silver book:      design and construction by Contractor

III. Allocation of risk, quality control and the method of pricing and payment

  • Three categories of valuation of contract depending on the extent of risk accepted by the Employer
    • Re-measurement contract (based on unit rates and prices)
    • Cost-reimbursable contract
    • Lump sum contract

1. Re-measurement contract (e.g. Red book)

  • Employer accepts the risk of variations in the quantities originally estimated and in some of the rates and prices tendered
  • particularly relevant in civil engineering works with a high content of ground surface work where the quantities are rather unpredictable
  • payment of the Contractor for the value of works executed in accordance with the contract
  • Bill of Quantities
    • key document in a re-measurement contract
    • consists of a number of items and a certain quantity to each item
    • number of steps that lead to the bill of quantities
      • detailed analysis of the design calculations, specifications and drawings
      • division into types of activities to be performed
      • division of each activity into items that are included in the bill of quantities
      • calculation of the quantity of each item from the drawings, specifications etc.
    • at the tender stage, prospective Contractors would fill in a proposed unit price or rate for each item
    • the contract price is then calculated by adding the priced items in the bill
    • purposes and advantages
      • conformity of tenders
        • cost of tender is reduced when not each prospective tenderer has to set up its own bill of quantities
        • conformity allows the use of the bill of quantities as a basis for analysis of the tenders and, thus, facilitates the comparison of the submitted tenders
      • basis for valuation of variations
        • if variations occur, the unit prices and rates in the bill of quantities can be used as a basis for valuation
      • basis for valuation of the work executed by the Contractor
        • basis for valuation for the purpose of interim certification and interim payment
      • at the end, basis for re-measurement of the items of work executed by the Contractor and for valuation of the final contract price

2. Cost-reimbursable contract

  • Employer accepts the whole risk of carrying out the work
  • Contractor is reimbursed for actual costs of carrying out the work + an additional amount of money in respect of profit
  • possible contracts
    • cost plus percentage fee
    • cost plus fixed fee
    • cost plus fluctuating fee
    • target price contracts

3. Lump sum contract (e.g. Yellow / Silver book)

  • Employer accepts the least amount of risk with respect to quantities
  • Contractor is obliged to carry out all the work included in the contract documents for a fixed specified tendered sum
  • useful where the quantities are expected to remain unchanged
  • However, usually a number of events that would entitle a Contractor to receive an extra payment (e.g. if the drawings and contract documents do not accurately describe the work or provide for specific alterations)
    • in this case, use of a bill of quantity for the reasons stated above (with the exception of re-measurement)

B. Specifications

  • separate document in addition to the drawings and outlines and the report on the project
  • form the key documents that describe the work and on the basis of which e.g. the items of the bill of quantities will be identified
  • two types of specifications
    • design specifications
      • describe precisely the materials to be employed and the manner in which the work is to be performed
      • afford no discretion to the Contractor
      • e.g. building of a bridge to cross a river at a certain point, starting from point A to point B, with a determined length and height above the water surface (for ships to pass underneath), two lanes each side for traffic etc.
    • performance specifications
      • describe precisely an objective or standard to be achieved in the end
      • successful bidder is expected to exercise ingenuity in achieving the result, selecting the means by which to achieve it
      • Spearin doctrine: implied warranty that if design specifications are followed, an acceptable result will be produced ’ relieving the Contractor of responsibility if the project fails to perform as the Employer’s expects
      • e.g. crossing of a river between (maximal) points A and B, not obstructing or delaying the shipping traffic on the river at any time, capable of dealing with a projected density of traffic of X
      • advantages
        • greatest possible amount of flexibility on the part of the Contractor
          • leaves it open to the Contractor what solution he develops to achieve the performance, e.g. whether to build a tunnel or a bridge
        • allows for more competitive pricing of Contractors on the basis of the aforesaid
          • e.g. one Contractor may be capable of building a bridge but may be more experienced (and therefore possibly cheaper and more reliable) in building tunnels
        • facilitates innovative approaches which the Employer might not have been aware of when initiating the project
      • disadvantages
        • only efficiently usable in design-and-build contracts or turnkey contracts
        • in contracts in which the main portion of design is provided by the Engineer (on behalf of the Employer) the flexibility which would be achieved by performance specifications would be prejudiced by the design already prepared by the Engineer and would not leave enough space for Contractors to make use of it
        • pure performance specifications in practice usually not possible
          • where government regulations, industry standards and the like are applicable, they are usually design standards
          • physical conditions at a project’s boundaries (access road elevations etc.) are design specifications
          • Employer needs to provide some preliminary design (as design specification) to be able to develop project cost estimates, for internal project approvals, to apply for project permits and government approvals, to be able to enter into long-term supply contracts etc.

C. Checklist for the use of FIDIC contracts

Simple projects

  • project is of relatively small value           or
  • construction time is short              or
  • the contract involves simple or repetitive work (e.g. dredging)
    - Short Form of Contract
    • it is not important whether the design is done by the Employer or the Contractor
    • it is not important whether the project involves construction, electrical, mechanical or other engineering work

Larger or more complex projects

  • Employer (or Engineer) is going to do most of the design
    • traditional projects, e.g. infrastructure, buildings, hydropower etc.
    • Engineer administers the contract, monitors construction and certifies payments
    • Employer is kept fully informed and could make variations
    • payment according to bills of quantities or lump sums for approved work done
      - Conditions of Contract for Construction (Red)
  • Contractor is doing most of the design
    • traditional projects (e.g. electrical and mechanical work)
    • project is required to fulfil the Employer’s requirements, i.e. an outline or performance specification
    • Engineer administers the contract, monitors construction and certifies payments
    • payment according to achieved milestones generally on a lump sum basis
      - Conditions of Contract for Plant and Design-Build (Orange / Yellow)
  • Privately financed project of BOT
    • concessionaire takes the total responsibility for the financing, construction and operation of the project
    • Contractor takes total responsibility for the design and the construction
    • higher degree of certainty that the agreed contract price will not be exceeded
    • project is required to fulfil the Employer’s requirements, i.e. an outline or performance specification
    • however, Employer does not want to be involved in day-to-day progress of the works
    • parties are willing to pay the Contractor more in return for the Contractor bearing the extra risks associated with enhanced certainty of the final price
      - Condition of Contract EPC / Turnkey Projects (emphasis on EPC)
  • Process plant / Power plant on a fixed-price turnkey basis
    • Contractor takes total responsibility for the design and the construction and will hand it over ready to operate at the turn of a key
    • higher degree of certainty that the agreed contract price will not be exceeded
    • strictly two-party approach, i.e. without an Engineer
    • Employer does not want to be involved in day-to-day progress of the works
    • Employer willing to pay the Contractor more in return for the Contractor bearing the extra risks associated with enhanced certainty of the final price and time
      - Condition of Contract EPC / Turnkey Projects (emphasis on Turnkey)
  • Infrastructure project (road, rail link, bridge etc.) on a fixed-price turnkey basis
    • Contractor takes total responsibility for the design and the construction and will hand it over ready to operate at the turn of a key
    • higher degree of certainty that the agreed contract price will not be exceeded, except that if underground works in uncertain or difficult ground conditions are likely then the risk of unforeseen ground conditions should be borne by the Employer
    • strictly two-party approach, i.e. without an Engineer
    • Employer does not want to be involved in day-to-day progress of the works
    • Employer willing to pay the Contractor more in return for the Contractor bearing the extra risks associated with enhanced certainty of the final price and time
      - Condition of Contract EPC / Turnkey Projects (emphasis on Turnkey)
  • Building project on a fixed-price turnkey basis
    • Employer and/or his Architect may have done some or most of the design, but with suitable modification regarding design responsibility
    • Contractor takes responsibility for the remaining design and the construction
    • higher degree of certainty that the agreed contract price will not be exceeded, except that if underground works in uncertain or difficult ground conditions are likely then the risk of unforeseen ground conditions should be borne by the Employer
    • Employer does not want to be involved in day-to-day progress of the works
    • Employer willing to pay the Contractor more in return for the Contractor bearing the extra risks associated with enhanced certainty of the final price and time
      - Condition of Contract EPC / Turnkey Projects (emphasis on Turnkey)