What Are the Risks of Poor Contracts Management in Construction? - Lceted

Understanding Contracts in Construction Projects

Contracts are the backbone of any construction project, serving as the legal framework that governs the relationships between the various parties involved. According to the classic legal definition, a contract is a promise or several promises under which the law recognizes a duty to perform, and for which a breach is actionable. In simpler terms, a contract is an agreement that creates legally binding obligations between the parties. For a contract to be valid and enforceable, it must be free from misrepresentation, mistake, duress, and undue influence.

To fully grasp the importance of contracts, it's essential to understand the six fundamental elements that constitute a contract:

1. Offer and Acceptance: A contract begins with an offer by one party and the acceptance of that offer by another. The terms of the offer must be clear, and the acceptance must be unconditional.
2. Consideration: This refers to something of value exchanged between the parties. It could be money, goods, services, or a promise to do or refrain from doing something.
3. Legal Capacity: All parties entering into a contract must have the legal capacity to do so. This means they must be of legal age, sound mind, and not under the influence of drugs or alcohol.
4. Legal Purpose: The contract must be for a lawful purpose. Any contract involving illegal activities is void and unenforceable.
5. Genuine Consent of Parties: Both parties must genuinely agree to the terms of the contract without being forced, tricked, or misled.
6. Agreement: Finally, the contract must be an agreement between the parties, with each party intending to create a legal relationship and be bound by the contract's terms.

Typical Parties Involved in a Works Contract

Construction projects typically involve multiple parties, each with specific roles and responsibilities. Understanding the roles of these parties is crucial for effective contract management. Here are the typical parties involved in a works contract:

1. Owners:
• Public Owner (Government Bodies): These are government entities that initiate and fund public infrastructure projects.
• Private Owner (Including Quasi-Public Bodies): These are private individuals or corporations that undertake construction projects for their use or profit.
2. Architects/Engineers (A/E): These professionals are responsible for designing the project and ensuring that it meets the necessary standards and regulations.
3. Prime/General Contractor: The general contractor is responsible for managing the construction project, coordinating with subcontractors, and ensuring the project is completed on time and within budget.
4. Subcontractors: These are specialized contractors hired by the general contractor to perform specific tasks, such as electrical work, plumbing, or HVAC installation.
5. Suppliers: Suppliers provide the materials, equipment, and other resources necessary for the construction project.
6. Banks & Financial Institutions: These entities provide the financing needed to fund the construction project.
7. Specialized Service Agencies: These agencies offer specialized services such as environmental assessments, safety inspections, and quality control.
8. Labor: The workforce that carries out the physical construction work.
9. Regulatory Agencies: Government bodies that oversee the construction project to ensure it complies with laws, regulations, and safety standards.
10. General Public: The community affected by the construction project, particularly in public works projects.

Types of Contracts in Construction

In construction, there are various types of contracts, each suited to different project requirements and risk distributions. Here’s a closer look at the main types of construction contracts:

1. Item Rate Contract: The contractor is paid based on the quantity of work completed, as measured by pre-agreed rates per unit of work.
2. Cost Plus (Reimbursable Contract): The contractor is reimbursed for the actual cost of the work plus a fixed fee or percentage for profit. This type of contract is often used when the scope of work is not well-defined.
3. Lump Sum Contract: The contractor agrees to complete the project for a fixed price. Any cost overruns are the contractor’s responsibility unless changes to the scope are authorized.
4. Design & Build Contract: The contractor is responsible for both the design and construction of the project. This contract simplifies the project by reducing the number of contracts the owner needs to manage.
5. EPC (Engineering, Procurement, Construction) Contract: The contractor is responsible for the detailed engineering design, procurement of materials, and construction. EPC contracts are common in large infrastructure projects.
6. Two-Stage Tendering Contract: This type of contract is used when the design is not complete at the time of tendering. The first stage involves selecting a contractor based on preliminary designs and costs, while the second stage finalizes the contract once the design is complete.

Other Contract Types (Common in Government Infrastructure Projects)

In addition to the standard contract types, several other contract types are commonly used in government infrastructure projects:

1. BOT (Build Operate Transfer): The contractor finances, builds, and operates a facility for a specified period before transferring ownership to the government.
2. BOLT (Build Operate Lease Transfer): Similar to BOT, but the contractor leases the facility to the government during the operational phase before transferring ownership.
3. BOOT (Build Operate Own Transfer): The contractor owns the facility for a specified period before transferring ownership to the government. This contract type is common in projects requiring significant investment and long-term operation.

Forms of Contract

The form of contract used in a project depends on the sector (public or private) and the specific requirements of the project. Here’s a look at the forms of contracts typically used in both sectors:

Public Sector Projects

1. CPWD (Central Public Works Department): The standard form of contract used for public sector construction projects in India, particularly those involving government buildings and infrastructure.
2. PWD (Public Works Department): Used for state-level government projects, this form of contract is similar to CPWD but tailored to the specific requirements of state governments.
3. Bespoke Contracts: In some cases, states may develop their own forms of contracts to address specific project needs and regional considerations.

Private Sector Projects

1. FIDIC (Fédération Internationale des Ingénieurs-Conseils): FIDIC contracts are widely used in international construction projects due to their standardization and balance between the interests of the parties. They are particularly common in private sector projects that involve multiple countries or complex contractual arrangements.
2. Typical Developer/Owner Contracts: Private developers or owners may use bespoke contracts tailored to their specific project requirements. These contracts are often negotiated on a case-by-case basis to address unique project challenges.

Why FIDIC?

FIDIC contracts are highly regarded in the construction industry for several reasons:

1. Unification of Terms and Clauses: FIDIC contracts provide standardized terms and clauses, reducing ambiguity and the potential for disputes.
2. Wider Application: FIDIC contracts are suitable for a wide range of construction projects, from small developments to large-scale infrastructure projects.
3. High-Quality Provisions and Logical Clause Sequencing: The contracts are well-organized, making them easier to understand and implement.
4. More Specific Provisions Concerning the Rights and Obligations of the Contract Parties: FIDIC contracts clearly outline the responsibilities and rights of each party, reducing the risk of misunderstandings.
5. Concise Language: The contracts use clear and straightforward language, making them accessible to all parties, regardless of their legal expertise.

Documents Forming Part of the Building Contract

A comprehensive building contract includes several key documents, each of which plays a crucial role in defining the scope, terms, and conditions of the project. Here are the documents that typically form part of a building contract:

1. Invitation to Tender (NIT): The document that invites contractors to submit their bids for the project.
2. Form of Tender (Offer Letter Including All Revisions): The contractor’s formal offer to undertake the work, including any revisions or clarifications made during the tendering process.
3. Annexure to Form of Tender (Appendix to Tender): Additional details or clarifications related to the offer.
4. General Conditions (GCC): The standard terms and conditions that apply to the contract, covering aspects such as payment terms, dispute resolution, and project management.
5. Special/Particular Conditions (SCC/PCC): Specific terms and conditions that apply to the particular project, which may modify or supplement the GCC.
6. Bill of Quantities (BOQ): A detailed list of the quantities and types of work required for the project, used to calculate the contract price.
7. Technical Specification: Detailed descriptions of the materials, workmanship, and standards required for the project.
8. List of Tender Drawings: The drawings provided during the tendering process that outline the design and scope of the project.
9. Tender Correspondence/Amendment to NIT/Corrigendum's/Addendums: Any correspondence or amendments made during the tendering process that clarify or alter the original tender documents.
10. Minutes of Pretender Meeting: The record of discussions held during the pretender meeting, where potential bidders can ask questions and seek clarifications.
11. Tender Clarifications/Qualifications: Any clarifications or qualifications made by the bidder in response to the tender documents.
12. Letter of Intent (LOI): A letter issued by the owner indicating their intention to award the contract to the contractor, subject to final negotiations.
13. Letter of Award (LOA): The formal document that awards the contract to the contractor, outlining the agreed terms and conditions.

Top 15 Conditions to Look for in Any Contract

When reviewing a construction contract, it's essential to pay close attention to specific conditions that can significantly impact the project's success. These conditions can be broadly categorized into commercial, time-related, and dispute-related conditions.

Commercial Conditions

1. Payment Terms: Clearly defined payment terms are crucial for maintaining cash flow throughout the project. The contract should specify the timing, method, and conditions for payments, including any advance payments, progress payments, and final payments.
2. Performance Guarantee: This condition requires the contractor to provide a guarantee, usually in the form of a bank guarantee, to ensure they will complete the work as per the contract terms.
3. Mobilization/Material Advance: This condition outlines any advances provided to the contractor for mobilizing resources or purchasing materials, along with the repayment terms.
4. Retention Condition: The contract may include a retention clause, where a portion of each payment is withheld until the project is completed and defects are rectified.
5. Escalation/Price Adjustment/Basic Rates: The contract should address how price adjustments for materials, labor, or other costs will be handled, particularly in long-term projects.

Time-Related Conditions

1. Contract Duration: The contract should specify the overall duration of the project, including the start and completion dates.
2. Master Construction Schedule/Programme: A detailed construction schedule should be included, outlining the key milestones and deadlines for each phase of the project.
3. Delays and Its Notifications: The contract should specify how delays will be managed, including the process for notifying the owner of any delays and the consequences of such delays.
4. Extension of Time Clause: This clause outlines the conditions under which the contractor can request an extension of time for project completion.
5. Force Majeure: The contract should include a force majeure clause, which allows for time extensions or contract termination in the event of unforeseen circumstances beyond the contractor’s control, such as natural disasters or political unrest.

Dispute-Related Conditions

1. Claims Compensation Clause: The contract should include provisions for handling claims for additional compensation due to changes in scope, delays, or other unforeseen events.
2. Liquidated Damages Clause: This clause specifies the amount of compensation the contractor must pay the owner if the project is not completed on time.
3. Suspension of Works: The contract should outline the conditions under which work can be suspended, either by the owner or the contractor, and the consequences of such suspension.
4. Termination of Contract by Either Party: The contract should include conditions under which either party can terminate the contract, along with the procedures and consequences of termination.
5. Dispute Resolution/Arbitration Clause: This clause outlines the process for resolving disputes between the parties, including the use of mediation, arbitration, or litigation.

Types of Delay Events

Delays in construction projects can arise from various sources, each with different implications for the project. Delays can generally be categorized into three types: employer delays, contractor delays, and neutral delays (force majeure events).

Employer Delays

Employer delays are caused by the owner or their representatives and can have significant impacts on the project timeline. Common employer delays include:

• Delay in Obtaining Relevant Statutory Approvals: Projects often require various approvals and permits from government authorities. Delays in obtaining these can stall the project.
• Delay in Payments: Late payments from the owner can disrupt the contractor’s cash flow, leading to delays in purchasing materials or paying workers.
• Delay in Approval of Samples, Materials, Mock-Ups, Design Mixes, etc.: Timely approval of these items is crucial for maintaining the project schedule.
• Discrepancies in Contract/Tender Documents: Inconsistencies or errors in the contract or tender documents can lead to confusion and delays as the parties work to resolve them.

Contractor Delays

Contractor delays are caused by the contractor’s actions or inactions and can lead to penalties or liquidated damages. Common contractor delays include:

• Non-Availability of Right Number of Resources: A shortage of labor, equipment, or materials can slow down the project.
• Non-Availability of Right Project Staff or Frequent Changes in Project Teams: High turnover or inadequate staffing can lead to inefficiencies and delays.
• Not Maintaining the Right Cash Flow at Every Stage of the Project: Poor financial management can result in delays in procurement and payment to subcontractors.
• Not Monitoring the Vendors/Subcontractors with Acumen Skillset: Failure to effectively manage vendors and subcontractors can lead to delays in their work.
• Not Maintaining the Procurement Strategy as Planned: Deviations from the procurement strategy can result in delays in obtaining materials or services.
• Not Adhering with H&S and QA/QC Protocols: Non-compliance with health, safety, and quality protocols can lead to work stoppages and delays.

Neutral Delays (Force Majeure Events)

Neutral delays are caused by events beyond the control of either party and are typically covered under force majeure clauses. Common neutral delays include:

• Excessive Rainfall/Cyclone/Drought/Climatic Changes/Epidemic/Pandemic: These natural events can halt construction work and delay the project.
• Any Political Changes Including Elections: Political instability, changes in government policies, or elections can disrupt the project.
• Law and Order Issues in the Locality/Town: Civil unrest, strikes, or other law and order issues can prevent workers from accessing the site or disrupt the supply of materials.

Record Keeping and Communications

Effective record keeping and communication are critical for managing construction contracts. Records serve as evidence of the work performed, decisions made, and any issues that arise during the project. Here are the types of records typically maintained in a construction project:

1. Emails: Email communication provides a written record of correspondence between the parties.
2. In & Outgoing Letters: Formal letters sent and received during the project, including notices, approvals, and requests.
3. Minutes of the Meeting: Records of discussions and decisions made during project meetings.
4. Daily Reports (DPR): Daily logs of work performed, resources used, and any issues encountered.
5. Weekly Reports (WPR): Summaries of the week’s activities, progress, and any challenges faced.
6. Monthly Reports (MCR): Detailed reports on the project’s progress, financial status, and schedule.
7. Site Instructions: Written instructions issued by the owner or their representative to the contractor.
8. Drawing Registers: Logs of the drawings issued and received during the project.
9. Pour Cards: Records of concrete pours, including details of the mix, location, and quantity.
10. Inspection Checklist: Checklists used to verify that work meets the required standards.
11. Submission of Documents to Authorities: Records of documents submitted to government authorities for approvals and permits.
12. Health & Safety Documents: Records of health and safety inspections, incidents, and compliance with regulations.
13. QA/QC & QMP Documents: Quality assurance and quality control documents, including inspection reports and test results.
14. Request for Information (RFI): Requests from the contractor to the owner or architect for clarification on the contract documents.
15. Variations/Change Order Instructions (VO/CO): Records of changes to the scope of work, including details of the changes, reasons, and costs.
16. Material/Sample Approval Transmittals: Records of materials and samples submitted for approval, including the date of submission and approval.
17. Design Approval Transmittals: Records of design documents submitted for approval and the date of approval.
18. Labor Induction Records: Records of workers inducted onto the site, including health and safety training.
19. Hindrance Registry: A log of obstacles that have hindered the progress of the work.
20. Shop Drawings – Submission/Approval: Records of shop drawings submitted for approval and the date of approval.
21. As-Built Drawings: Drawings that reflect the actual construction as completed.
22. MCP Submission, Tracking & Revisions: Records of the submission, tracking, and revisions of the Master Construction Programme (MCP).
23. Confirmation of Verbal Instructions (CVI): Records of verbal instructions given during the project, confirmed in writing.
24. Early Warning Notices (EWN): Notices issued by the contractor to warn the owner of potential risks or delays.
25. Monthly Interim RA Bills – Submitted & Certified: Records of interim payment applications submitted by the contractor and certified by the owner.
26. Payment Receipt Records: Records of payments received by the contractor.
27. Photographs: Photographic evidence of work progress, issues, and completed work.
28. Videos/Text Messages: Video recordings or text messages related to the project.

Why Contracts Management is Essential in Projects?

Contracts management is a crucial aspect of project management in construction. It ensures that all parties are fully aware of their contractual obligations, risks are identified and mitigated, and the project proceeds smoothly. Here’s why contracts management is essential:

• Timely Identification of Risks and Steps to Mitigate Them: Contracts management helps identify potential risks early, allowing for proactive measures to mitigate them.
• Proactive Thinking and Notification to Employer: Contracts management encourages a proactive approach to potential issues, ensuring that the owner is notified of any risks or delays in a timely manner.
• Understanding the Repercussions of Non-Identification/Non-Notification/Non-Remedying of Risks or Delays: Failure to identify or address risks can lead to disputes, delays, and financial losses. Contracts management helps prevent these issues by ensuring that risks are managed effectively.
• Understanding the Repercussions of Non-Adherence/Non-Conformities to Contractually Agreed Terms and Specifications: Non-compliance with the contract terms can lead to penalties, disputes, and project delays. Contracts management ensures that all parties adhere to the agreed terms.
• Understanding the Scope for Claims (Extra Items/Variations/Idle Claims, etc.): Contracts management helps identify opportunities for claims, ensuring that the contractor is compensated for additional work or delays.

By effectively managing contracts, construction projects can minimize risks, avoid disputes, and ensure successful project completion.