Pricing and payment under construction and supply …...17/03/2015 1 Pricing and payment under construction and supply agreements David Nancarrow DLA Piper Australia 17 March 2015

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Pricing and payment under construction and supply agreements

David Nancarrow

DLA Piper Australia

17 March 2015

Introduction

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"A penny saved is a penny earned"

- Benjamin Franklin

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Pricing vs Payment

Pricing – how the total amount payable is determined

Payment – how the amount payable is paid

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Structures for pricing

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Number of possible ways to structure pricing:

Lump sum or fixed price

Guaranteed Maximum Price (GMP)

Provisional sum (or provisional sum items)

Cost reimbursable (cost plus)

Schedule of rates

Most appropriate structure will depend on the particular circumstances and nature of the work

Contracts can include a combination of pricing methods

Pricing structure is not the same as the contract structure

Lump sum = pricing structure

EPC, Turnkey, etc. = contract structure

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Lump sum / fixed price

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Contractor provides fixed sum for the completion of the whole of the works

Rarely is it absolute – usually subject to adjustment

Suitable when extent of work is known and workcan be can be accurately priced

Not appropriate if the scope of work is not known or well defined at the commencement of the contract

Can be easy to administer

Lump sum/fixed price method impacts on relationship between principal and contractor

Lump sum / fixed price - variations

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Contract will invariably allow the fixed price to be increased in certain circumstances:

usually when the scope of work has been varied by the principal; or

for cost increases which the contractor could neither reasonably foresee or control, such as latent conditions, industrial action and change in law.

Should be clear processes set out in the contract for claiming and determining a variation

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Provisional sums

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Provisional sums are used when the principal has not yet decided whether to include certain items as part of the scope or the items are to be included but the quantity or type is not yet known

Process for converting the provisional sum into a confirmed part of the scope must be clearly set out in the contract

Key issues to consider and document include:

clear description of scope

reasonable estimate (the provisional sum)

process for pricing

Contractor entitlement to profit

Cost reimbursable

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Cost-reimbursable or cost-plus structure compensates the contractor for the costs of the work completed with added amounts for profits and overheads

Principal carries the risk of project costs increasing

Requires detailed records and verification of costs to be reimbursed (often referred to as "open-book")

Can be an appropriate method when quantities are unknown or if the works involve new or complex methods or technology

Allows for greater potential for transparency in relation to costs and profit

$0.00

$100.00

$200.00

$300.00

$400.00

$500.00

$600.00

$700.00

Time

Cost

Costs + Profit

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Schedule of rates

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Amount to be paid is based on an agreed price per unit of construction

Unit of construction may be based on:

time (e.g. hourly rate)

quantity of material (e.g. tonnes of soil removed)

quantity of construction completed (e.g. kilometres of pipe laid)

The contract specifies units used and their value in a schedule usually called "schedule of rates"

Risk allocation:

principal bears risk of quantity necessary for job

contractor bears risk for fluctuation in unit prices

Currency fluctuations

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Currency of pricing and payment is critical for cross border projects where:

key items sourced for construction are priced in a currency different to the payment price

where parties are headquartered in different jurisdictions and principally operate in different currencies

Risk of currency fluctuations can be hedged against

Fluctuations in exchange rates can also work in favour of a risk-bearing party

Allocation of currency fluctuation risk should be expressly dealt with in the contract

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Rise and fall

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The direct costs of performing the construction contract are likely to rise and fall during the course of construction

Not all risk cannot be controlled by the principal or the contractor

Contracts may provide mechanisms for adjusting contract price to reflect changes in costs

Cost adjustment may be applied to labour or materials

If there is no adjustment mechanism for the rise and fall of long-term costs, contractors may when tendering:

overestimate the costs (inflating the project costs) or

underestimate the costs (risking the financial viability of the project)

Options for payment

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Options for payment:

advance payments

progress payments

milestones

value of work completed

on-site

off-site

fixed

Cash flow is critical

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Structures for payment – progress

payments

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Value of work completed progress payments are the most common structure for payment in major projects

Contractor remunerated for work completed during a given period

Progress payment process:

contractor submits a description of work completed during the previous time period, along with details of the value of the work

completed work is certified and valued

contractor is then paid the certified value of that work minus any retention, advance payment deduction or any other sum owing from the contractor to the principal

Progress payment as interim payment

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Progress payments are not final determinations of the value of the works

Progress payments are an interim assessment of the value of the works

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Materials not yet incorporated

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Contract must clearly state when the contractor is entitled to be paid for materials which is ordered and partially complete but not yet incorporated into the works

Must state:

the materials and equipment that will be paid for;

the amounts payable;

timing and requirements for payment.

Other issues to be dealt with are:

when does title pass/who bears the risk/who must insure the materials; and

the impact of the Personal Property Securities Act 2009 (Cth) (PPSA)

Subcontractors and employees

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Timing:

responsibility of contractor to ensure that the timing of payment provisions under a main contract align with the timing of payments to subcontractors under any subcontracts

Information requested from the subcontractor for payment should align with the information required under the main contract

"Pay if paid" and "pay when paid" arrangements are prohibited by law throughout Australia

A contractor cannot make the payment of its subcontractor contingent on the contractor being paid by another person (such as the principal)

a provision of a construction contract that purports to do this has no effect

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Security of payment

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Each state has enacted legislation

In WA it is Construction Contracts Act 2004 (WA)

Key provisions include:

act applies to defined work carried out in WA

prohibition on pay if/when paid clauses

maximum 50 days from claim to payment

implied provisions if contract is silent on payment progress

dispute adjudication process

Set off

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Right of set off common in construction contracts

Set off rights allow the principal to set off any amounts owing from the contractor to the principal from any amounts the principal is otherwise obliged to pay the contractor under the contract

For example:

if contractor owes principal liquidated damages for late completion; and

principal also owes progress payments to the contractor; then

principal can deduct the amount of the liquidated damages owed from the progress payments the principal owes to the contractor.

Liquidated Damages

Progress Payments

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Interest

Suspension

Termination

Security of payment adjudication

Dispute resolution

Remedies for non-payment

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Conclusion

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Consider and agree methods that are best for project

Ensure contract drafting is detailed and clear

Train contract administrators

Comply with the contract

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Questions

Key Contacts

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David Nancarrow

Partner

T: +61 8 6467 6028

[email protected]