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CONSTRUCTION CONTRACTANALYSIS
Robert Zellmer, CCAManagerBaker Tilly
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OVERVIEW
Today’s topics:Contract Key TermsDocumentation RequirementsRed Flags
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LEARNING OBJECTIVE
Deepen management’s understanding of construction contract terminology and the financial components of the contract
Identify contract strengths, weaknesses, and financial risks
Identify controls or actions necessary to mitigate risk
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CONTRACT RISK ANALYSIS
What is a construction contract risk analysis?
Documentation of the construction project financial risks and their respective project controls intended to protect the owner’s project interest
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CONTRACT RISK ANALYSIS
Why is this important?Ensure contract administered per intentIdentify contract terms that are not
beneficial to the ownerMitigate potential overcharge risksStrengthen weak or undefined contract
termsReduce the risk of dispute
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CASE STUDY – CONTRACT ADMINISTRATION
Background:Medical science buildingApproximately $30 million GMP
construction contractCompleted on timeMinimal change ordersAll stakeholders were satisfied with the
project
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CASE STUDY – CONTRACT ADMINISTRATION
Where is the risk?Contractually required cost reconciliation
was not performedManagement did not require cost supportBoth sides treated as a lump sum contract
ResultImproper administration resulted in an
overchargeContractor credited the owner approximately
$300,000
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CONTRACT TYPE
Lump Sum:Usually less than $10 millionFacility is fully designedDesigns are simple and often a duplicate of
another facilityThere are fewer unknowns that lead to
change orders
Benefits:Known financial commitmentLess owner’s administrative burden Less risk of scope creep and budget overrun
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CONTRACT TYPE
Guaranteed Maximum Price (GMP)Usually used on larger projectsProject nature is complex with unknownsOften coupled with a concurrent design process
Benefits:Establishes a not-to-exceed priceEnables the owner to benefit from value
added engineering, price reductions, and well managed procurement
Enables the owner to select and contract with the contractor while still designing the facility
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CONTRACT TYPE
GMP ContinuedDisadvantages:
Requires a more complex contract that specifies as much as possible
Burdens the owner with more project management and administration
Project complexity leads to more opportunity for aggressive or abuse behavior
Contractors like to believe that their budget is the entire maximum price
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KEY TERMS
Key Terms that Apply to All Contracts:Owner’s ResponsibilitiesContractor’s ResponsibilitiesAllowable and non-allowable reimbursable costsTerms for general conditions/general requirements
reimbursementPayment application documentation requirementsChange order process for scoping, pricing, and
approvalProcess for using and reporting contingency budgetProcess for handling owner allowances and creditsSubstantial completionRight to audit
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COSTS OF THE WORK
Definition of allowable and non-allowable costs:Materials, supplies, and equipmentSubcontractor costsSelf-performed construction costs
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GENERAL CONDITIONS
General conditions is the contractor’s compensation for overhead and indirect project cost.
Lump sumCost reimbursable
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CASE STUDY – LUMP SUM GENERAL CONDITIONS
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CASE STUDY – LUMP SUM GENERAL CONDITIONS
Additional Background:The lump sum value of general conditions
was billed in fullSavings of approximately $650,000 were
returned to the ownerChange orders were very detailed and well
documented
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CASE STUDY – LUMP SUM GENERAL CONDITIONS
Audit Results:Approximately $200,000 in general
conditions costs were allocated to other SOV line items and charged to the owner
Contractor stated the owner approved the charges
No approval documentation provided
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GENERAL CONDITIONS
Costs typically included in General Conditions:Job site trailer and utilitiesWinter conditionsSmall tools chargeProject manager and principal labor chargesAdministrative and overhead costsLayout yard and construction material storage Value engineeringAccounting and project reporting
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GENERAL CONDITIONS
Costs that are not typically included in General Conditions:
InsuranceGeneral foremen and supervisory costsPickup trucks and transportationConstruction material purchasing and
transportationComputer and office equipment
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GENERAL CONDITIONS – BENCHMARKING
Benchmarking against comparable projects can be an effective analysis tool.
Cost per square footCost per contract dayPercent of total costs
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GENERAL CONDITIONS – BENCHMARKINGGeneral Conditions Benchmarking
Project 1 - 100% CDs Project 2 - 75% CDsSummary of Costs Amount AmountCM Construction Stage Personnel 4,008,274$ 1,372,981$ General Conditions 2,442,122$ 1,694,243$ Subcontracts 83,244,444$ 25,801,956$ Subtotal 89,694,840$ 28,869,180$ Contingency 1,121,186$ 577,418$ COW + Contingency 90,816,026$ 29,446,598$ Fee 1,135,200$ 588,965$ GMP 91,951,226$ 30,035,563$
30,035,494$ 69$
General Conditions Analysis
General Conditions 2,442,122$ 1,694,243$ Project Calendar Days 778$ 470$ GCs per Day 3,139$ 3,605$
Recalculated at Project 1 Daily Rate 1,475,318$ Variance 218,925$
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GENERAL CONDITIONS
Labor burden:Labor burden is the incremental cost employers cost to carry an employee on the crew. Typical labor burden costs are:
Employee benefitsEmployers social securityWorkman’s compensation insuranceHealth and safety Federal and state unemployment taxUnion assessments (pension, training, etc)
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GENERAL CONDITIONS
Labor burden should not include:Contractor markup or profit marginOverhead allowanceVehicle allowanceTool allowanceUnion dues
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GENERAL CONDITIONS
Labor burden risks:Overcharging for allowable burden costsCharging for non-allowable costsDouble charging for costs also covered by
general conditionsDouble charging for costs that are specific
pass through expenses
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PAY APPLICATION DOCUMENTATION
Pay Application (Invoice) Documentation:Each month the pay application should be accompanied by:> Job cost detail> Material invoices and receiving tickets> Time sheets for self-performed work> Subcontractor invoices> Equipment logs for contractor provided
equipment> Lien waivers> Equipment rental invoices
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PAY APPLICATION DOCUMENTATION
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RECONCILIATION OF PROJECT EXPENDITURES
Job cost detail should include all hard and soft costs, and should be reconciled to the pay application.
Soft costs are the indirect costs associated with the construction project, such as: General conditions Construction management fee Insurance and bonding Hard costs (the direct costs for constructing the facility) Materials, supplies, and equipment Subcontractor costs Self-performed construction costs
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CHANGE ORDER CONTRACT PROVISIONS
Change order provisions should include the following:
Definition of major and minor change orderAuthority for approving each type of change
orderAuthority for using contingency budgetChange order documentation requirements
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CHANGE ORDER CONTRACT PROVISIONS
Change order documentation should include:Who is performing the workCost breakdown of materials and labor with
quantities and rates for eachContractor markupClear description of the scope of workClear description of why the change order is
necessary
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CHANGE ORDER RISKS
Change order risk categoriesUnauthorized change ordersUnnecessary change ordersRedundant or duplicate change ordersOverpriced change orders
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CONTRACTOR’S CONTINGENCY
Contingency provisions should include the following:
Allowable useApproval authorityDocumentation and reporting requirementsTreatment of unused funds
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CONTRACTOR’S CONTINGENCY
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PROJECT CLOSEOUT
Substantial completion
Documentation requirements
Cost savings
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SUBSTANTIAL COMPLETION
Substantial completionDefinedHow verifiedOwner’s remedies if not met
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LIQUIDATED DAMAGES
Liquidated damages are an amount of money that contracting parties agree on as the amount of damages one of them can recover if the party breaches the contract.
Typically for work not completed on timeDefinedEnforceableRealistic
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LIQUIDATED DAMAGES
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GMP ANALYSIS
Shared Savings CalculationThis is an incentive program mutually agreed upon between the owner and contractor to share in savings that arise from:
Value engineeringAggressive purchasing strategiesContractor’s supplier relationships
Shared savings risks: Inflated GMPMaterials that are commodity priced should be
excluded from the shared savings calculation.
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Questions?
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CONTACT INFORMATION
Thank you for participating today!
Robert Zellmer, CCAManagerBaker [email protected]
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DISCLOSURERequired firm disclosure and Circular 230 Prominent Disclosure The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party.