Contracts, Change Order Administration and Claims Management Dieter J. Preiser, PMP.

Contracts, Change Order Administration

and Claims Management

Dieter J. Preiser, PMP

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What is a Contract?

A contract is a mutual business agreement recognized by law under which one party undertakes to do work (or provide a service) for a second party for a “consideration”.

A contract is an agreement between two parties, one called the contracting party or owner and the other the contracted party or the contractor to perform a previously determined scope of work for a previously determined amount of money.

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Why do we need written contracts? Basic lack of trust Clearly establishes the risks and obligations of each party Provides means by which performance can be assessed and

measured Provides means by which breaches can be identified Provides means by which default can be established Establishes the owner’s means of control Establishes the contractor’s scope of work

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What does a written contract do for us? A written contract provides the document

by which risks, obligations, and relationships of both parties are clearly established, thus ensuring the performance of these elements in a disciplined manner.

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Goals of Contract Management and Administration The effective management and

administration of contracts results in reducing risks, maximizing cost savings, minimizing claims, and improving economic return.

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How do contracts minimize risks? A contract provides the means to manage and allocate

risks. You you want to “share” the risks appropriately through your contractual relationship.

Your contracting strategy needs to be built around the relationship between the terms and conditions, and the accompanying risks and cost impacts.

The type of contract and the specific language used should flow from these relationships.

Failure to manage risks in this manner can result in cost overruns, loss of market, or loss of quality.

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Risk Areas

Cost - possibility of overruns and other financial losses

Time - delays in schedule and resultant loss of market

Quality - loss of desired quality of engineering and construction

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Contracting Strategy

Priority of project management goals– Cost, schedule, quantity

Status of project definition Schedule and cost constraints

– Facility startup date and availability of capital

State of the economy– Market urgency for product

– Number of competitive bidders

– Workload of competitive bidders

– Vendor backlogs

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Types of Contracts

Lump-sum fixed price Unit price Fixed price with escalation (price adjustment)

Guaranteed maximum price (target price) Cost plus incentive fee (time/cost goals) Cost plus fixed fee Cost plus percentage of cost

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Elements of Cost

Labor Costs Material Costs Equipment Costs Overhead Costs - Direct and Indirect Profit

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Analysis of Cost

DIRECT COST INDIRECT COST

Costs which are incurred for specific

items of work

Costs which cannot be

allocated to specific jobs

Differencebetween allcosts andall income

Costs which cannot be

allocated tospecific items

The Work The Site The Firm The Motive

Profit MarginItems of Work

At the Job Operating

COST FEE

TOTAL CONTRACT SUM

OVERHEAD COSTS

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Fixed Price vs. Cost ReimbursableDefinitions Fixed Price

Agreement to perform the scope of work at a set price regardless of Contractor’s actual cost.

Cost ReimbursableAgreement to perform work on a reimbursable basis.

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Fixed Price vs. Cost ReimbursableBasic ConditionsFixed Price

Fair and reasonable price can be established using a detailed scope of work, complete design and specifications and known environmental and business conditions.

Adequate professional inspection & supervision provided by other parties.

Risk: Contractor assumes maximum amount of risk, and has incentive to perform economically.

Cost ReimbursableScope & cost of work not defined sufficiently to allow fixed price quotes.

Qualified contractors unwilling to accept financial risk of fixed price.

Owner wishes to exert more control, develop design as project progresses, or achieve technology transfer from contractors.

Owner is required to be more sophisticated in contractor selection and oversight.

Risk: Owner accepts most risk

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Fixed Price vs. Cost ReimbursableAdvantages Fixed Price

Less risk on the Owner, at least on the surface.

Substantial amount of case law and administrative protocol.

Overall cost known before project begins.

Minimal Owner involvement

Owner realizes price competition.

Contractor has incentive to finish early.

Cost ReimbursableConstruction can be phased.

Changes can be accommodated more easily.

Reduces adversarial relations:Contractor & Owner are partners.

Reduced Contractor contingency included in price.

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Fixed Price vs. Cost ReimbursableDisadvantages Fixed Price

Adversarial relations

Contractor may bear risk for conditions beyond his control

Changes more likely to end in dispute.

Contractor has no direct financial motivation to provide superior quality or service.

Extra time required to complete the plans and specs.

Cost ReimbursableGenerally, the construction costs are higher.

Increased Owner involvement.

Final cost not known until project is finished.

More detailed negotiations and contractor selection process.

More cumbersome administrative and bookkeeping requirements.

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Fixed Price vs. Cost ReimbursableApplicability Fixed Price

Routine projects.

Conditions with an abundance of qualified contractors.

Public works projects.

Cost ReimbursableHigh-risk industrial or manufacturing projects (petrochemical, power, offshore).

Situation where qualified contractors are scarce.

R&D projects (aerospace, military).

Types of ContractsLump Sum

Lump Sum + Variation

Bill of Quantities

Schedule of Rates

Cost + Fixed Fee

Cost + % Fee

(Contract Type)

Admeasurement

Cost Reimbursable

Max

Min

Ow

ner’

s C

ontr

ol

Ow

ner's

Fle

xibi

lity

Client‘s Risk

Contractor's Incentive to Perform

Client’s Project Definition

MaxMin

MaxMax MinChangeableFirm

Min

Max

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Project Schedule Duration vs.Type of Contract

1. Cost Reimbursable w / %Fee2. Cost Reimbursable w / Fixed Fee3. Cost Reimbursable w / Incentive4. Guaranteed Maximum Price5. Lump-Sum Fixed Price

Engineering Requiredto Start Construction

Construction

Project Completion

Start ofConstruction

Project Duration

Con

trac

t T

ype

1

2

3

4

5

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Phased Construction

Design

Bid/Award Construction PhaseDesign

Construction Phase

(Single Construction Contract)

(Multiple Construction Contracts)

Lan

dsca

pe

Site

wor

k

Foun

dati

ons

Stru

ctur

es

Mec

hani

cal

Ele

ctri

cal

Phased Construction Method

Traditional Construction Method

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Precontracting Activities

PreparePre-Qual

Documents

EstablishPlan ofAction

PrepareManagement

SubmittalManagement

Review

ReleasePre-Qual

ContractorsDevelopResponse

Score Pre-Quals

and PrepareBid Slate

Bid SlateManagement

Approval

PrepareContract

Draft

ReviewContract

Draft

ReviseContract

Draft

PrepareJob Ex

Meeting

ReleaseBid

Package

Job ExMeeting

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Pre-Contracting Activities

ContractorPrepares

Bid

PrepareCompany Estimate

FunctionalReview

PrepareManagement

Recommendation

ManagementReview

PrepareContract

ReceiveBids

TechBid

Review

PriceBid

Review

ContractAward

ContractorSigns

OwnerSigns

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Pre-Qualification Process

Financial Strength and Credit Rating Previous Experience on Similar Projects Organization Loss Prevention Program QA/QC Program Equipment Availability Availability of Key Personnel Current and Future Workload

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Components of Contract Package

Invitation for the Bid Instructions to Bidders Bid Form Contract Form Schedule of Plant General Conditions or Provisions Special Conditions, Supplementary Conditions

or Special Provisions

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Components of Contract Package

Performance Schedule Price Schedules Scope of Work Specifications

– Performance Specification– Proprietary Specification

Design Drawings

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Contract Bonds

Bid Bond (5% to 10% of contract price) Performance Bond (50% of contract price) Payment Bond Maintenance Bond

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Insurance

Public Liability Insurance– Provides coverage against bodily injury and property damage

to third parties as the result of construction activities.

Builder’s Risk Insurance– Protects against loss/damage of structures and equipment

Comprehensive Automobile Liability Insurance Special Policies

CHANGE ORDER ADMINISTRATION

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Change Order Administration

An organized effort to eliminate unnecessary cost and time impact as a result of processing project work outside the scope of the contract.

A Change is not a Claim.

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Contract Change Clause

Fixed price contract require a change clause.

Establishes the owner’s right to make changes and provides a mechanism for their administration and resolution.

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Types of Changes

Formal– Via contract change clause

Constructive– Action of owner that has the effect of directing a

change, although not initially documented as such.

Cardinal– Change totally out of scope of original contract.

– Should re-negotiate entire contract.

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Change Orders

Virtually all project have change orders. Need to recognize their implications. Set up an effective management system to

handle them. Minimize cost/time impact and prevent

costly legal action. Modification of the contract.

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Sources of Change Orders

Unanticipated site conditions Owner requested design modifications,

additions or deletions Clarification of contract documents

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Disagreements

Change or design development Scope of the change Material cost Equipment rental rates Acceptable profit Overhead cost Consequential effects of the change

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Change Orders

Prior approval– Adverse effect on construction

Unilateral change order– Urgent situations or conditions

After the fact

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Change Order Process

Change OrderIdentification

C.O.Request

C.O.Design

Cost/Schedule Analysis

Bid Period

Bid Analysis

PrepareBid Package

Bid Closing

C.O. Award

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Cost of Changes

Time

Engineering Construction

Flexibility

Cost

CLAIMS MANAGEMENT

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Typical Claims Against Owner

Poor project planning Scope changes Constructive change orders Errors and omissions Contract accelerations and stoppages Site access or availability Other construction interference and delays Strikes and acts of God Low bidders

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Typical Claims Against Contractor Late completion - liquidated damages Out of specification materials Defective work Property damage

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Delays

Excusable Delay– Beyond control of owner or contractor

Inexcusable Delay– Beyond the control of the contractor

– Owner caused changes to work

– Differing site conditions

– Suspension or termination of work by owner

Concurrent Delay– Two or more delays in same time frame

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Claims Analysis

Brief of the case Owner’s position Contractor’s position Analysis and evaluation Recommendations

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Claim Prevention Suggestions

Carefully analyze and consider exactly what you are building and precisely how it will be built so the contractor does not have to assume or guess about any aspect of the job.

Complete the project design before the contract is bid, and if some parts of the project cannot be completely designed at bid stage, clearly identify them and its possible impact.

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Claim Prevention Suggestions

Conduct a thorough review of the design prior to the bid stage to identify and correct any design errors or inadequacies.

Give bidders sufficient time to carry out a complete review of the bid package and an investigation of the construction site.

Allow enough construction time, remember in this context, time is not money. Do not assume that bidders will simply increase their bids to cover a short schedule.

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Claim Prevention Suggestions

Identify with enough anticipation what type of contract will best suite the project.

Think about every sentence included in the contract, why it is there and whether it is necessary.

Clearly identify in the contract every operation that the contractor must accomplish to complete the job.

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Claim Prevention Suggestions

Draft for clarity, not confusion. Use standard list of definitions, and always use the same defined word consistently.

Consider material arrival schedules as part of the contract. Identify long-lead items and possible vendors in the bid package. Avoid sole-source procurement unless absolutely necessary.

Clearly identify who will be responsible for material delays.

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Claim Prevention Suggestions

Analyze all potential bidders before preparing a bid slate. Examine contractors’ prior contracting experience, claims history, management capabilities and financial ability.

Carefully analyze contractors’ technical proposal paying particular attention to the proposed method of construction and the planned number of man-hours claimed necessary to execute the job.

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Claim Prevention Suggestions

Seriously question the contractors’ excessively low bid.

If you are forced to accept a low-ball contractor, anticipate a claim and work on it from the beginning.

Be reasonable when analyzing the contractors’ complaints about changes and omissions. Negotiate settlement as soon as possible and keep in mind that the older the issue, the more difficult it will be to settle.

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Claim Prevention Suggestions

Appreciate the contractors’ right to perform the contract in any fashion he deems appropriate, as long as the methods and results conform to contractually specified standards.

Keep in min that the owner has the obligation to provide: a suitable construction site, accurate plans and specifications, well-defined scope of work, and inspection without interference.

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Claim Prevention Suggestions

Understand how many factors can affect a contract and delay and disrupt the work. Cooperate to establish an atmosphere of understanding and mutual respect.

Keep strict control of: progress reports, daily meetings, schedule revisions, cost estimates, change orders and their justifications, correspondence.

Develop a solid document control plan.

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Contract Disputes ResolutionContinuum

Budget and Contract

Pre-constructionMeeting

A Problem andRequest for Information

Change Order

Request

Change Order Estimate andNegotiation Settlement

Phase II - Contract Administration (LOW COST RESOLUTION RISK)

PM SelectionPolicies and Procedures

Risk Assessmentand Allocation

Identify DisputesResolution in Contract

Review ContractDocuments for Completenessand Accuracy

Budget andContract

Phase I - Program/Project Planning (NO COST RESOLUTION RISK)

Denial ofEntitlement

and CostChange Order

Issued

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Contract Disputes ResolutionContinuum

ConstructionMaster Mediation Mini-Trial

Rent-a-Judge/Jury

Phase IV - Outside Intervention (HIGH COST RESOLUTION RISK)

Rapid ResponseTeam

DisputesReview Board

NegotiationsInvolving the

Party Principals

ContractingOfficer’sDecision

Selection of Outside

Intervention Options

Phase III - Contract Identified Resolution (MEDIUM COST RESOLUTION RISK)

Denial ofEntitlement

and Cost

Selection ofVenue Options

Selection of Outside

Intervention Options

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Contract Disputes Resolution Continuum

SettlementHearings

Non-BindingArbitration

BindingArbitration Litigation

Phase V - Arbitration and/or Litigation (MAXIMUM COST RESOLUTION RISK)

Selection ofVenue Options