MRO Magazine

Reviewing your contracts for services


Industry

December 14, 2001
By PEM Magazine

You need to draft a contract whenever outside services are required. The form of the contract can be informal, such as a purchase order referencing a proposal by the contractor. It can also be very formal, requiring bids along with detailed descriptions of the work and expectations of how the work will progress.

TYPES OF CONTRACTS
Contracts for services take a number of forms. Lump-sum and unit-price contracts are commonly used as a result of bids submitted by more than one contractor. Negotiated contracts can be let by a company to one or more firms. The contractor may be chosen, not so much for price, but rather for dependability, experience, or skill.

The payment method can be lump-sum, unit-price, combination lump-sum unit-price, cost reimbursable with a ceiling, cost-plus a fixed fee, cost-plus a percent of costs, construction management contracts, and incentive-type contracts.

Lump-sum

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A lump-sum contract, also called stipulated sum, is suggested whenever it is possible for a potential contractor to make a precise survey of the work involved or when detailed drawings are available. The contractor will be paid one price (lump-sum) for the work performed, independent of the costs and time expended.

Unit-price

With a unit-price contract, the contractor must estimate the labour and material used in definable units, such as number of man-hours or number of cubic yards of concrete required for the project.

These units are then multiplied by a unit price to obtain the extended cost for each item. Payment to the contractor will be based on the actual number of units expended, as opposed to the estimated units.

Lump-sum and unit-price

This contract type is used when some parts of a potential job are well documented but others are not. A lump-sum bid is submitted for the known portion and a unit-price bid is submitted for the less known portion.

Cost reimbursable with a ceiling price

In this agreement, the contractor is to be reimbursed for all costs as listed in the agreement up to a maximum cost. The words "not to exceed" may appear on a purchase order to affirm the maximum cost.

Cost-plus fixed fee

This is an agreement similar to "cost reimbursable with a ceiling" except that a fixed fee is established for services rendered. This fee must be paid in addition to the itemized reimbursable costs. The terms of the contractor must define the points where completion will be measured and controls must be put on certain expenditures.

Cost-plus percentage

This contract is the same as "cost-plus fixed fee" except that a percentage of the reimbursable cost is added to obtain the final payment. This may be undesirable to some buyers because the contractor’s compensation for services increases with the costs of the project. The contractor’s incentive may be to build up costs to increase their fee.

Construction management

This type of contract requires the contractor to divide the work into trade segments. The contractor is usually the prime contractor who acquires bids from and hires trade subcontractors. The buyer reimburses the prime contractor for all subcontracts, as well as a profit for the prime contractor for managing the contract.

Incentive-type

Incentive-type contracts provide for bonuses to be paid to a contractor for completing the job ahead of time or penalties for late completion.

CONTRACT REVISIONS
Contracts or bids must be changed from time to time. Certain standard documents are required to explain these changes.

Addenda

Sometimes revisions must be made during a bidding process. Addenda are provided to clarify or add drawings and specifications. These changes are usually a result of questions posed by prospective bidders. Addenda can also be used to change the dates of the bidding process.

Stipulation

In some jurisdictions, the buyer may modify the contract after the bid is awarded but just before execution. This change is provided in the form of a stipulation document. The contractor must agree to this stipulation prior to beginning work.

Change order

Changes in a contract while work is proceeding must be documented with a written order provided by the buyer. More often than not, a change order is applied to changes in a lump-sum contract. A change order is used when minor changes have occurred and when the general scope of the work has not. Changes that exceed a certain percentage, like 25 percent, may be too excessive for a change order. In these cases a supplementary agreement must be prepared.

Supplementary agreement

When changes occur which are outside the general scope of the original contract, you must develop a supplementary agreement. In some cases, a supplementary agreement can be a complete rewrite of the contract. Both parties must sign this new agreement.

THE BIDDING PROCESS
Bids are often required for construction work and services when many different contractors can perform a particular job. Companies use the bidding process as a cost control measure and as a method to reduce collusion.

The bidding process begins with an advertisement or invitation for bids. Sealed bids may be invited by advertising in newspapers and engineering publications for legally required periods. The advertisement should contain an issuing location, date of issue, date for receipt of bids and time of opening of bids, brief description of the project, location of the project, quantities of major items of work, office where plans and specifications can be reviewed, proposal security, and rights reserved to the owner.

More often than not, bids are requested by invitation to a selected group of contractors. The invitation conveys much of the information that would be included in an advertised bid package.

Bidding requirements

Bidding requirements for a company may be spelled out using a general provision section like the one used in a standard contract. The main points to be covered are the qualifications required of a contractor, the preparation of the proposal, the proposal guarantee, a non-collusion affidavit, and a statement on how the proposal is to be delivered.

Qualification

For a bid to be acceptable, the bidder must either be pre-qualified by the buyer or must furnish financial or other information to prove they are capable of performing the work. A license, required in some U.S. states and Canadian provinces, may be all that is required.

Preparation

The proposal should be laid out on forms provided by the buyer to avoid irregularities on the part of bidders which could nullify the bid. These proposals should be signed, notarized, and sealed into envelopes provided by the buyer.

Proposal guaranty

A bond may be required, usually at 10 percent of the estimated contract value, to assure that the contractor can do what they state they can do in the proposal. The bonds posted by the unsuccessful bidders are returned.

Non-collusion affidavit

A non-collusion affidavit is generally required by public agencies in some North American jurisdictions but should also be added to commercial bid requests. This document states that the vendor will not collude with another vendor or with a site employee to obtain the contract.

Delivery of proposal

A bid may be delivered by mail or messenger but must be received before the time set for opening; otherwise, it may not be accepted.

Most bids are evaluated based on price alone. If other factors concerning the job are important, such as technical competence, the bids may be evaluated with a predetermined point system. Once a decision is made, the buyer officially notifies the successful bidder that they have been awarded the contract. The bidder is then expected to execute the contract agreement within the specified time.

The general provisions or general conditions are included in the first section of the contract. A number of technical specification divisions may follow for each major part of a project. Applicable standards should be cited in the last section of the contract.

GENERAL PROVISIONS OF A CONSTRUCTION CONTRACT
The general rights and responsibilities of the parties to a contract are spelled out in the general provisions. This language in a contract is sometimes referred to as "boiler plate", or "the legals", even though no part of the contract is required by law. The general provisions in a contract may not have all of the above sections and some contracts may use different terminology, but the basic idea of this section in any contract still holds.

Definitions and abbreviations

Definition of terms and abbreviations used in the contract.

Bidding requirements

Instructions included in a bidding document, such as the invitation or advertisement for bid, instruction to bidders, bid form, and bid bond.

Contract and subcontract procedure

This section, found in both bid documents and contracts, should include a discussion of the contract bond and progress schedule requirements. A description of how contracts will be awarded and how the contract will be executed can be included in this section. A subcontracting provision, or provision on whether or not a contract can be assigned will usually be part of this section. A description of recourse for failure to properly execute the contract will also be included.

Scope of work

The scope of work is made up of statements that describe the work to be performed, cleanup requirements, and final acceptance.

Availability of space and storage for the contractor should also be discussed in this section. Permissible deviation from estimated quantities of labour and material should be spelled out with a statement in this section.

Control of the work

This section will include the names of site personnel responsible for contract completion, a procedure for handling change order requests, inspection procedures and acceptance requirements (if not already spelled out in the scope of work). Field office and other facility requirements may be included. Rules for relations with other contractors should be included if more than one competing contractor will be on site. Control requirements for site documents and plans should be spelled out. Receipt, inspection, tagging, and handling construction materials at the site should also be addressed in this section.

Legal and public relations

The general provisions of a contract will also include legal and public relations provisions to identify the legal requirements between the contractor, buyer and general public. The purpose of this section is to assure that liabilities for actions arising from the work are assigned to the proper party and that this party should be held accountable to make good all claims.

Damage claims: Wording which indemnifies and holds harmless officers and employees of a company is common in a construction contract. Indemnification is an obligation, assumed or legally imposed, on a party to protect another against loss or damage from stated liabilities. The words "hold harmless" may also be used to state the contractor’s obligation in this matter. Damage claim provisions apply to all associated subcontractors as well. Essentially, the work is performed entirely at the contractor’s risk. The contractor is usually required to provide insurance to cover this provision, since the buyer cannot count on the financial capability of the contractor. This insurance will include the following:

  • Worker’s Compensation — in statutory limits;
  • Comprehensive General Liability (Property Damage, Contractual Liability, and Personal Injury);
  • Comprehensive Automobile Liability.


Laws, ordinances, and regulations:
The contract must follow all applicable federal and provincial laws as well as local ordinances. Any licenses and permits required to perform and complete the project must be acquired by the contractor.

Responsibility for work: The contractor is responsible for material and equipment used while performing on the contract. No claims are allowed against the buyer for damages to this material or equipment. The contractor must make good all damage caused by the contractor.

Sanitary provisions: The contractor may be required to maintain sanitary facilities for personnel.

Public safety and convenience: The contractor should conduct work so as to inconvenience the public as little as possible. Steps should be taken to install temporary crossings, take measures to prevent deposits of earth or other materials on roads, and to keeping flying dust to a minimum.

Accident prevention: The contractor must observe all the safety provisions and rules required of current site personnel. The contractor is responsible to provide safe working conditions on the project.

Property damage: The contractor is obligated, when using private property, to correct any damage they make.

Public utilities: The contractor must be advised to take care around public utilities such as water, natural gas, and electricity. All costs associated with avoiding and temporarily moving these utilities are the responsibility of the contractor.

Abatement of soil erosion, water pollution and air pollution: Contractors must minimize soil erosion, muddying of streams, irrigation systems, impoundments, and adjacent lands. Fuels, lubricants, and other liquid materials must not be discharged into adjacent waters.

Prosecution and progress

Another part of the general provisions should deal with how work will start and proceed, the point of completion, suspension of the work, unavoidable delays, default of contract, liquidated damages, and extension of time.

Commencement and prosecution of the work: The date the work is to start and the date it must be completed should be spelled out. Construction should progress in a manner that ensures completion according to a progress schedule. A statement should be made as to whether operations will be limited at the site including traffic and work by others.

A statement should also be made about the required ability, adequacy, and character of workers the contractor employs and about the sound basis of the construction methods and equipment used by the contractor.

Time of completion: The number of calendar days from date of commencement should be spelled out rather than working days. The buyer may specify a date or time which they will be begin using the constructed item, event if it is partially completed. A particular feature of the work that must be completed to allow subsequent jobs to progress should be spelled out here. This is especially important if the work described in this contract is only part of a larger project.

Suspension of work: The buyer should be able to stop all work by the contractor if they feel it is necessary. So as not to breach the contract or prevent the contractor from fulfilling the contracted obligations, the buyer must identify all situations that may permit them to stop work. Conditions such as weather, a strike, failure to perform up to the expectations of the buyer, or due to unsafe conditions or acts by the contract employees, are all commonly identified.

Unavoidable delays: The contractor may be granted an extension in the contract time under certain conditions. However, the contractor is not necessarily entitled to compensation unless specifically spelled out in this section.

Annulment and default of contract: The contract can be terminated under annulment or default. Annulment is when court order or plant management stops all work. The contractor is usually compensated for all costs incurred to stop work and make the site safe. Default occurs on the part of the contractor when the project is delayed or abandoned unnecessarily. Default can also occur if the contractor willfully violates terms of the contract or carries out the contract in bad faith. The buyer may use all contractor-furnished material and equipment to complete the project. Any bonds posted by the contractor may be used by the buyer to hire another contractor and complete the project.

Liquidated damages: The contractor is to pay the buyer each day of delay in completing specified stages or the complete contract beyond the dates due. This may provide an incentive to the contractor to finish on time.

Extension of time: Just cause may exist for an extension of the stipulated time for completion of the project. These may include change orders, suspension of work, or delay of work for other than normal weather conditions.

Measurement and payment

The general provisions of a contract should provide for measurement of amounts of the completed work and the amount for payment of each level.

Measurement of quantities: All completed work of the contract will be measured for payment according to standard measures.

Scope of payment: Payment for a measured quantity for a unit-price bid will constitute full compensation for performing and completing the work and for furnishing all labour, materials, tools, equipment.

Change of plans: What should be done when the measured quantities of work completed or materials furnished are greater than or less than the estimated quantities originally proposed?

Payment: A procedure for partial payment should be laid out for longer jobs. The buyer may retain a percentage of the amount of the contract, pending completion of the contract.

Termination of contractor responsibility: Upon completion and acceptance of all work included in the contract and payment of final certificate, the project is considered complete and the contractor is released from further obligation and requirements.

Gurantee against defective work: A guarantee period should be established for all or portions of the work, together with an amount of guarantee, usually calculated as a percentage of the contract cost.

TECHNICAL SPECIFICATIONS
There are three basic forms of technical specifications in a contract. They are:

Materials and workmanship specifications

Almost always found in a contract, materials and workmanship clauses cover the general and special conditions affecting the performance of the work, material requirements, construction details, measurement of quantities under the scheduled items of work, and basis of payment for these items.

Material procurement specifications

When many separate general construction contracts are in force at the same time, a material procurement specification is usually added. This is especially true if some of the contracts are for similar types of work. This section would include a statement about the fabrication processes as well as all the elements of materials and workmanship specifications, except for the field construction details.

Performance specifications
Performance specifications are used mostly in procurement contracts for machinery and plant operating equipment. Technical descriptions may be made for each functional area of a construction project and may broken down as seen in Figure 3.

Description: Under this heading, a concise statement is made of the nature and extent of the work included in the section and its pertinent features, including the requirement that work conform to the plans and specifications.

Materials: When it is important to the quality of the work, materials of construction should be specified in a contract. The principal properties to be considered in the preparation of specifications of materials for construction are:

1. Physical properties, such as strength, durability, hardness, and elasticity

2. Chemical composition

3. Electrical, thermal, and acoustical properties

4. Appearance, including color, texture, pattern, and finishes

Inspections, tests, and analysis made by the manufacturer of the material should be acquired by the contractor and later provided to the buyer.

Sometimes the "Materials and Workmanship" section of the contract covers all that’s required for materials specifications. The words "or equal", "or approved equal", "or equal as approved" are often used if a precise standard may be two restrictive.

Construction requirements: This section is a detailed description of requirements sited in the "General Provisions — Control of the Work" section and of all the work required to complete the project.

Measurement and payment: This is a more detailed accounting of the payment method described in the "General Provisions — Measurement and Payment" section as it applies to a specific part of the project.


Michael V. Brown is part of the Milford, CT-based New Standard Institute. Founded in 1991, New Standard Institute provides maintenance management consulting and technical training services to industrial clients. For more information, visit www.newstandardinstitute.com.