Project Contract Management

Project Contract Management

Project contract management manages and administers contracts throughout the project lifecycle. It ensures that project team members have well-defined responsibilities and work together towards the same goal. It removes any confusion and disputes and ensures the successful completion of the project.

A project contract is a formal contract between the project team and the business detailing what will be delivered to the business, by when, and what the business will provide to the project team to enable the successful delivery of the project.

Contracting is ubiquitous in project management. In projects, every work is done according to formal or informal contracts. Even in internal projects where users and contractors belong to the same organization, the objectives, requirements and statements of work are documented such that user expectations are known and that contracted work will conform to them. Most projects, however, involve some degree of external, legal contracting, because most require the user to formally hire an external organization to perform the work.

As the below image explains, this “external organization” might itself be a composite of many organizations linked by numerous contractual agreements.

First, the user contracts with a principal party (the prime contractor of SDO) to be responsible for the overall project, in turn, this party might contract with secondary parties sub-contractors, vendors, consultants, material suppliers and contract labour (union trade professionals) to be responsible for portions of the project, these secondary parties might then contract with tertiary parties.

Project Contracting

Project contracting involves several considerations. In addition to asking what should be done and how it should be done, the question of who will do it needs to be put forth. The RFP/proposal process addresses that question not only for the user but for any party seeking to hire another to do work.

In every situation, the contractor, the secondary contractor or anyone else down the line, everyone follows a structured process similar to the Request for Proposal (RFP) process. This process is important for documenting the needs, gathering ideas and selecting the most suitable contractor for the job. 

By contracting the work, the customer is not necessarily relinquishing control over the project. He should maintain a certain level of control over the project. To that end, the contract should specify the customer’s role in tracking progress and making trade-off decisions and identify those project areas where the customer has authority for decisions or supervision over the contractor.

The agreement must be effectively managed from the moment the contract is reached until the project is completed or terminated successfully. This involves ensuring that work performed is in conformance with the contract and that the contract is up-to-date concerning ongoing changes in the project, the project, the customer’s needs and the contractor’s capability. This process is called contract administration.

Sub-Contracting

Each party must decide whether it will do the work itself or hire someone else. Some contractors do all the work; others require outside assistance, in which case they sub-contract. Construction is an example of a general or prime contractor hired by a user to manage the overall construction project and perhaps fabricate and assemble the building structure. For specialized work such as wiring, plumbing, ventilation and iris details, however, the contractor may subcontract with other organizations to do the work.

Even when a contractor could, conceptually, do all of the work, they may choose to sub-contract if they are limited by capacity or facilities or believe that a sub-contractor could do the work at a lower expense on higher quality. For development projects of large-scale systems, the prime contractor will usually design the overall system, and major subsystems (and possibly assemblies and components) and then decide which elements of the system to produce and which to sub-contract. When significant portions of project work are to be done by sub-contractors, the user will often mandate prior notification about and approval of the sub-contractors.

Sub Contracts

Usually, obligations in subcontracts exist solely between the contractor and sub-contractor. That means, eg that the contractor (not the user) is responsible for ensuring that the sub-contractor performs work according to the requirements and the contractor (not the user) is obligated to pay for the sub-contracted work. Similarly, whenever the user wants to change the requirements, communication about those changes is channelled through the prime contractor to the sub-contractor.

The specific type of contract agreement appropriate for a sub-contract depends on the type of agreement between the user and the prime contractor. If this agreement (the prime contract) is fixed price, then contracts should also be fixed price; otherwise, the prime contractor risks being charged more by subcontractors than he will be paid by the user. For prime contracts that are cost-plus or incentive, the contractor has more latitude in using a variety of types of sub-contracts. 

Types of Contracts

Given below  are the types of project contracts:

1. Cost Plus Contract
2. Lump Sum Contract
3. Unit Price Contract
4. Turn-Key Contract

1) Cost Plus Contract

This contracting method can take one of several forms. Typically, it is one in which the contractor agrees to perform the work for direct costs plus a negotiated percentage markup. The costs are considered to include all materials, equipment and labour (often not including general supervisory or overhead staff labour). This method can be modified by agreeing upon a fixed fee instead of a percentage markup. A simple form of this contract used in construction projects is the Time and Materials (T&M) contract. Under this agreement,  the contractor charges the owner for the cost of the material (sometimes with a markup depending on the agreement) and bills the owner for labour provided at its current or negotiated rates.

Advantages of Cost Plus

i) A cost-plus contract is a good option in time-sensitive, emergency or other fast-track situations, when there is not adequate time to prepare complete plans and specifications, especially in the case of very small projects.

ii) It may also be a good option when there are many unforeseen conditions, such as tunnelling or foundation work. The contractor, in this case, is responsible for maintaining clear and accurate records of project expenditures and providing those records to the owner for payment.

Disadvantages of Cost Plus

i) This contracting method does not allow for knowledge of the final cost of the project until the project is complete. Not knowing the final cost presents budgeting difficulties and the open-ended risk can negatively impact the rise of project funding.

ii) Scheduling and other difficulties may also arise due to the uncertainty of the project completion date. These risks can be somewhat mitigated if a cost-plus fixed fee arrangement is considered, in which the contractor is obligated to complete the work for the stipulated fee regardless of the final cost of the job. This arrangement will also often motivate the contractor to complete the project as expeditiously as possible, presumably to move its staff on to other projects.

2) Lump Sum Contract (or Firm Fixed Price)

This is a commercial distinction which refers to the fact that all of the work included in the contract will be done by the contractor for a predetermined and agreed price. A great deal of risk is assumed by the contractor. A very well-defined scope of work is required to properly use this type of contract:

i) Bid: The lumpsum contract is generally bid by three to five bidders and is based on firm scope and specifications. For a large, complicated project the preparation of the bid is an expensive proposition. The owner should not request any more bids than are necessary to achieve his purpose of getting a good competitive price from a qualified contractor.

ii) Negotiated: If getting a project completed as soon as possible is the primary objective or if there is only a single qualified contractor for the work, then a negotiated, lumpsum price may be indicated.

iii) Multiple Fixed Priced: Here the contract duration is short. Small speciality sub-contractor capability can be well utilised. Sub-contractor coordination between several subs may be difficult.

Advantages of Lump Sum

This approach benefits the owner, as he will know precisely how much the project will cost from the beginning, excluding any additional scope changes requested by the owner throughout the construction process.

Disadvantages of Lump Sum

i) This contracting method places much of the risk on the contractor, as compensation will be based on the amount bid to complete the project, even if the contractor encounters cost overruns during the construction process. For that reason, the owner must provide completed plans and specifications to the bidding contractor to allow for the development of a comprehensive price estimate. The owner or the contracted engineer may still bear the risk of cost overruns and other liabilities due to errors or omissions in the plan and specification package.

ii) Unless all or at least most, of the details of the project, are known and specified, this contracting method may not be appropriate. Unknown details, which are the responsibility of the contractor will force the contractor to inflate the bid price to protect against serious unrecoverable cost overruns.

However, this process can work well for the experienced and organized contractor, who can benefit from effective project management by value-engineering cost savings, thereby increasing effective profit This method is generally not recommended for emergencies or other time-sensitive situations in which complete plans are typically not developed or in cases in which there are many other circumstances out of the contractors control such as weather hazards.

3) Unit Price Contract

This contracting method involves the payment based on the cost per unit of service the contractor’s control, such as weather hazards. This method is preferable when a project requires stone, concrete or earth. the provision of large quantities of similar items,

Advantages of Unit Price

1) It can also be used for projects requiring the same type of materials as well as labour throughout the job, such as the replacement of standard light fixtures throughout a facility.

ii) This allows a contract to be executed without requiring final drawings and SOW to be completed. Unit Price provides flexibility in adding or subtracting to adjust the Statement of Work (SOW) from the original plan based on unit price adjustments. This may require the establishment of some minimum fixed cost base or adjustment factors that ensure that fixed costs can be recovered if the SOW is reduced. Conversely, a unit price reduction may be appropriate once a certain quantity is exceeded.

Disadvantages of Unit Price

1) This contracting method requires a large quantity of book-keeping

ii) It may also not be compatible with highly diversified work, where there are many types of activities, each with a moderate number of units. Furthermore, similar to the cost-plus method, the owner will not be aware of the project cost until the end of the construction period.

iii) Construction limits should be carefully considered when using this approach. Items such as lighting fixture quantities can be estimated and documented.

4) Turn-Key Contract

In this contract, the entire responsibility of project execution is entrusted to the contractor. It is as if the owner comes into the picture only when the project is completed and turns the key of the plant to start production. The contractor takes care of all aspects of project execution until the project reaches the ‘ready-to-start’ stage,

This type of contract is used when the project requires high technology, the know-how is not available with the project owner but the contractor is well-versed in both the technology and know-how needed for the project. There may be some projects that involve the integration of many areas, of which, the project promoter is conversant only with certain areas while the owner has to depend on others for some other areas of the project In such situations also, the turnkey contract is preferred to fix the responsibility for execution and completion of entire activities to a single point.

Since the contractor of a turnkey project is expected to do everything right from scratch, the scope of the contract covers all areas of the project, viz., design, engineering, construction, structural work, supply and erection of plant and machinery, supply of spares, testing and commissioning. Since the entire work is done by a single contractor, turnkey contract agreements invariably have a clause on performance guarantee Turnkey contracts may be for the whole project or even for a sub-unit of a main project. A turnkey contract for a sub-unit is undertaken when such a sub-unit is a separately identifiable component of the total project and whose performance can be assessed independently of other units of the project.

Advantages of Turn-Key

i) This method can help to expedite a project for several reasons. Since completed plans and specifications are not required to allow contractors to bid on the project, the project schedule can be accelerated by eliminating bidding time that is no longer necessary.

ii) It is also possible for preliminary construction work to begin or long lead-time materials ordered, while final design documents are being developed.

Disadvantages of Turn-Key

i) There is also one line of responsibility for both design and construction, reducing or eliminating the ability of the party to assign blame to another entity if problems occur.

ii) This approach places the design risk on the contractor (builder). Not only will the contractor offer a firm bid price based on an incomplete design (which will only be completed later by the contractor), but if the design is flawed, the contractor will be responsible for all necessary corrections, presuming the contractor had legitimate access to known existing conditions.