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Technical Seminar

Tips on Contract Management14 March 2005Speaker : Ms Lily Heo

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Contents• General understanding of contract

• Common Types of Contract Strategies

• Cost Control

• Management of Variation and Claim

• Performance Monitoring

• Contract Completion and Closure

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What is a Contract?• Established where there are commitments and

agreements to buy and sell.

• Represents the total legal obligations originated from agreement between parties.

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Elements of Contract

• Mutual assent evidenced by offer and acceptance

• Consideration and form - supported by something of value in exchange

• Competent parties – must be capable of contracting but not a minor, mentally ill, intoxicated person

• Legality of purpose

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Why Contract is Important

• Failure to comply with agreed terms will be a breach of contract

• Either party may claim for damages

• Parties will rely on the contract provisions in the event that dispute is put to court proceedings

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Contract Documents

• Tender Documents:• Instructions to Tenderers

• Specification, General / Specific Requirements

• Conditions of Contract

• Contractor’s Proposal• Form of Tender & Appendix

• Bill of Quantities

• Drawings

• Letter of Acceptance / Purchase Order

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Key Terms in a Contract• Definitions• Parties, roles and

responsibilities• Specifications / Statement

of Work• Confidentiality• Intellectual Property Rights

(IPR)• Regularity issues eg.

safety, environmental, statutory requirements

• Contract Prices• Payment Term• Indemnities, warrants

and insurance• Liquidated Damages• Defect Liability Period• Termination• Disputes and Arbitration• Force Majeure

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Factors on Contract Strategy

• Project Timeline• Price Certainty• Quality Level• Design involvement• Apportionment of Risk• Project Complexity• User of Contractor’s Expertise• Involvement of Client

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Contract Strategy

• Turnkey Arrangement (Design & Build)• One single contractor is appointed to undertake the entire

project including design and provision of equipment and subsequent implementation

• Advantage :• Maximum responsibility on one contractor• Should achieve a timely completion due to total ownership

• Disadvantage :• No wayout when the work is underway• Limited choice of supplier base may increase the project cost

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Contract Strategy (cont’d)

• Traditional Client-coodinated Arrangement• Client takes responsibility for appointing different specialist

consultants / contractors for individual work packages (eg. architect, E&M contractor, building contractor etc.)

• Advantage :• Better value of money • Maintain high degree of discretion on selecting contractors

• Disadvantage :• Require a lot of resources to develop specifications and

selection of consultants / contractors• Require resources for co-ordinating various consultants /

contractors

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Contract Strategy (cont’d)• Partial Turnkey

• A hybrid or halfway between full turnkey and client-coordinatd arrangement

• Client undertakes the responsibility for the organising of a number of work packages eg. design package, independent to implementation packages

• Advantage :• Client owns greater responsibility for particular parts

• Disadvantage :• With greater responsibility on particular area, client will share

risk of delays and cost overrun• More effort on managing contractors

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Contract Strategy (cont’d)• Management Contracting

• Developed in construction industry• Client appoints an independent design team called

“Professional Team” led of architect or Project Manager and the main contractor, “management contractor” for the organisation and supervision of work for the project

• Advantage :• Achieve cost economies and save time by integrating design

team and management contractor• Disadvantage :

• Risk of cost underestimation by the design team

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Cost Control

• Cost control program provides a systematic forum for reducing the total project cost, without affecting quality.

• Three aspects of cost control program :• Cost reduction – effort to trim the costs eg. select

alternative material / method / process• Cost avoidance – effort to prevent any cost increase via

value analysis, negotiation etc.• Cost containment – hold costs within certain target limit via

value analysis, negotiation etc.

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Selection of Pricing Method

• Fixed Price Contract :• Firm fixed price• Fixed price with adjustment / escalation• Fixed price with incentive

• Cost Reimbursable Contract :• Cost plus incentive fee• Cost sharing• Time and material contract• Cost plus fixed fee

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Selection of Pricing Method (cont’d)

• Fixed Price Contract :• Firm fixed price• Fixed price with adjustment / escalation• Fixed price with incentive

• Cost Reimbursable Contract :• Cost plus incentive fee• Cost sharing• Time and material contract• Cost plus fixed fee

Buyer Risk Contractor Risk

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Value Analysis / Engineering

• Value Analysis and Value Engineering are used interchangeably

• Value Analysis focuses on existing products and systems and co-ordinates all functions in an operation to reduce overall cost of the production

• Value Engineering analyses the functional requirements of a new design / product / procedures used in production in order to achieve the lowest cost without loss of performance, quality and reliability

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Definition of Variations

• It is an “alteration or modification of the design, quality or quantity of the Works” specified in the contract

• A variation has only limited scope and can’t be used to change the essence of the contract

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Cause of Variations• Inadequate design work• Changes of mind or requirement after the contract

has been signed• Change in the method of performing work• Unforeseen circumstances eg. Change in technology

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Impact of Variation• Increased cost• Increased time necessary to complete which will

affect :• Insurance• Preliminary• Additional consultancy cost• Other expenditure or financial loss eg. Loss of potential

rent.

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Cost of Variation

The cost of the variation may be calculated by :• An agreed price• Measurement and valuation by a Quantity Surveyor (QS) in

accordance with Bill of Quantities or Daywork Schedule etc.

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Variation = ClaimVariation is an alteration of the works whether by way of addition, modification or omission

Claim refers to additional monies sought by the contractor. It can be made for the payment of damages due to the buyer’s breach of contract, that constitutes delay completion of work.

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How to Minimise Variation & Claim• To include a clause covering variations to minimise

the risks associated with cost and time within the contract

• To ensure a good contract management / project management system embedded with contract

• To maintain open and clear communication

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How to Deal with Them• All reasonable efforts should be made to avoid

variations• Variations should be subject to a clearly defined

procedures within the contract• When unavoidable, variations and claims should be

negotiated

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Assessment during Negotiation • What will be the possible outcome ?• Will the result affect the relationship ?• Is there sufficient time for the negotiation ?• Are we clear of what to be achieved ?

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Some Negotiation Techniques• Opening – avoid making the opening bid• Testing – get information on counterpart’s position• Active listening• Use silence to encourage more information flow• Keep concession for trading / exchanging• Try avoiding excessive conflict• Prepare persuasive and logical arguments• Focus on interests, not positions• Invest in options for mutual gain

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Negotiator Style• Logical Negotiator – provides factual arguments• Relationship Negotiator – focus on relationship• Intuitive Negotiator – led by intuitions• Tough Negotiator – result oriented and unconcerned

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Common Dispute Settlement Methods• Arbitration – both parties present their cases to

arbitrator(s) who will then decide how the case should be settled. The decision is binding and is enforceable through the courts. Unlike litigation, the arbitration cases are private. They can be less costly and be handled quickly.

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Common Dispute Settlement Methods (cont’d)

• Mediation – With the aid of a mediator who will listen to and question each side to lead a settlement. A mediator does not make a binding decision.

• Re-negotiation – Both parties place all difference on the table for re-negotiate the contract

• Litigation – If unable to resolve, a party may sue for damages suffered as a result of contract breach. It will then be decided in the courts according to the law. It will take a lot of time and cost.

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Performance Monitoring

• Establish performance monitoring system in contract• Define stakeholders• Agree evaluation criteria and measurement method / key

performance indicator (KPI)• Determine whether KPI will be associated with incentive

payment• Agree impact of the measurement result

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Contract Closure• Contract is considered completed when the required

certificates have been issued by the client :• Completion Certificate – when the work is substantially

completed• Taking Over Certificate – when the plant has passed test• Acceptance Certificate – when the performance test has

been passed• Final or Maintenance Certificate - at the end of defects

liability period

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Tips to Those who Manage Contracts• Clear understanding of contract itself including

specification, performance measures and all contractual terms

• Access to management information that details how the contractor is performing

• Establish contract management framework eg. meeting and reporting interval

• Effective teamwork and relationship management

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Reference• Study Guide – Project Management and Contract Management

for Purchasing and Supply, The Chartered Institute of Purchasing & Supply

• The C.P.M. Study Guide, National Association of Purchasing Management (currently called Institute for Supply Management)

• Building Services Procurement, Christopher Marsh