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The Main Types of Contracts in Project ManagementFebruary 5, 2022
The Main Types of Contracts in Project Management
Contracts consist of three main types:
- Lump sum contracts
- Remeasured contracts
- Reimbursable contracts
It is possible to have a subcontract that is a combination of two or even all three types. For example, a mechanical erection subcontract could have design content that is a lump sum fixed fee, a remeasured piping erection portion and a reimbursable section for heavy lifts in which the client wants to be deeply involved. The main differences between the three types are as follows.
Lump Sum Contracts
A prerequisite to a lump sum (a fixed price) contract, with or without an escalation clause, is a complete set of specifications and construction drawings. These documents will enable the subcontractor to obtain a clear picture of the works, assess the scope and quality requirements and produce a tender that is not inflated by unnecessary risk allowances or hedged with numerous qualifications.
The trend in the USA is to have all the designs and drawings complete before tenders are invited and, provided such usual risk items as sub-soil, climatic and seismic conditions are clearly given, a good competitive price can be expected.
Most lump sum contract documents should, however, contain a schedule of rates, so that variations can be quickly and amicably costed and agreed. Clearly, these variations should be kept to a minimum and must not exceed reasonable limits, since the rates used by the subcontractor are based on the tender drawings and quantities and a major change could affect his man-hour distribution, supervision level and site organization.
A common rough limit accepted as reasonable is a value of variations of 15% of the contract value. It must be stated that a variation can be a decrease as well as an increase in scope and although the quantities may be reduced by the client, the reduction in price will not be proportional to that reduction.
Indeed, when a subcontract includes a design element, a reduction in hardware (say the elimination of a small pump), may increase the contract value due to costly drawing changes and cancellation charges.
Most civil engineering subcontracts in the UK are let as remeasured contracts. In other words, the work is measured and costed (usually monthly) as it is performed in accordance with a priced bill of quantities agreed between the purchaser and the subcontractor.
The documents that are required for the tender are:
- General arrangement drawings
- Bills of quantities
The bills of quantities are usually prepared by a quantity surveyor employed by the purchaser and are in fact only approximate, since the only drawings available for producing the bills are the general arrangement drawings and a few details or sketches prepared by the designers.
Obviously, the more details available, the more accurate the bills of quantities are, but since one of the objectives of this type of contract is to invite tenders as quickly as possible after the basic design stage, full details are rarely available for the quantity surveyor.
The subcontractor prices the items in the bills of quantities, taking into account the information given in the drawings, the specification, the preambles in the bills and, of course, the location and conditions of the proposed site.
Although the items in the bills of quantities are often described in great detail, they are included only for costing purposes and do not constitute a specification. In the same way, the quantities given in the bill are for costing purposes only and are no guarantee that they will be the actual quantities required.
As with lump sum contracts, variations, which inevitably occur, must not exceed reasonable limits in either direction, since these could invalidate the unit rates inserted by the subcontractor.
For example, if the bills of quantities call for 10,000m3 of excavation of a depth of 2m, and it subsequently transpires that only 1000m3 have to be excavated, the subcontractor is entitled to demand a rerating of this item on the grounds that a different excavator would have to be employed, which costs more per cubic metre than the machine envisaged at the time of tender.
In remeasured subcontracts, it is a common practice to carry out a monthly valuation on site as a basis for progress payments to the subcontractor.
These valuations consist of three parts:
- Value of materials on site, but not yet incorporated in the works
- Value of work executed and measured in accordance with the method of measurement stated in the bills of quantities
- Assessed value of preliminary items and provisional sums set out in the bills
The value of materials, which have been paid for in a previous month (when they were delivered, but not yet incorporated in the works), is deducted from the measured works in the subsequent month (by which time they were incorporated) since the billed rates will include the cost of materials as well as labour and plant.
At the end of the contract period, the final account will require a complete reconciliation of the cost and values, so that any overpayments or underpayments will be balanced out.
When a client (or purchaser) wishes to place a contract as early as possible, but is not in a position to supply adequate drawings or specifications, or when the scope has not been fully defined, a reimbursable contract is the most convenient vehicle.
In its simplest form, the contractor (or subcontractor) will supply all the materials, equipment, plant and labour as and when required, and will invoice the client at cost, plus an agreed percentage to cover overheads and profit. To ensure ‘fair play’, the client has the right to audit the contractor’s books, check his invoices and labour returns, etc., but he has little control over his method of working or efficiency. Indeed, since the contractor will earn a percentage on every hour worked, he has little incentive in either minimizing his man-hour expenditure or finishing the job early.
To overcome the obvious deficiencies of a straight reimbursable (or cost-plus) contract, a number of variations have been devised over the years to give the contractor an incentive to be efficient and/or finish the job on time. Most cost reimbursable contracts have two main components:
- A fee component that can cover design costs, site and project management costs, overheads and profits
- A prime cost component covering equipment, materials, consumables, plant, site labour, subcontracts and site establishment.
In some cases, the site establishment may be in the fee component or the design costs may be in the prime cost portion. The very flexibility of a reimbursable contract permits the most convenient permutation to be adopted.
By agreeing to have the fee portion ‘fixed’, the contractor has an incentive to finish the job as quickly as possible, since his fee and profits are recoverable over a shorter period and he can then release his resources for another contract. Furthermore, since he only recovers his prime cost expenditure at cost, he has absolutely no advantage in extending the contract – indeed, his reputation will hardly be enhanced if he finishes late and costs the client more money.
If the scope of work is increased by the client, the contractor will usually be entitled to an increase of the fixed fee by an agreed percentage, but frequently such an increase only comes into effect if the scope charge exceeds by 10% of the original contract value.
The factors to be considered when deciding on the constitution of the fixed fee and prime cost components are:
- Time available for design
- Extent of the client’s involvement in planning and design
- Extent of the client’s involvement in site supervision and inspection
- Need to permit operations of adjacent premises to continue during construction. This is particularly important in extensions for factories, hotels, hospitals or process plants
- Financial interest of the client in the contractor’s business or vice versa
- Location of site in relation to the main area of equipment manufacture
- Importance of finishing by a specified date, e.g., weather windows for offshore operations or committed sales of product