4.2 Contracts

School of Civil and Environmental Engineering
CENG 5104: CONSTRUCTION MANAGEMENT

Chapter 4
Procurement and Contracts
4.2 Contracts
Contents
Contracts
1. Contract: Definition
2. Elements of Contract
3. Effects of Contract
4. Construction Contracts
5. Types of Construction Contracts
AAU, AAiT, Construction Management, 2020, Fasil T.

 Generally, a contract is an agreement or willful promise

enforceable at law.
 However, not all agreements or promises are contracts as
some agreements may lack enforceability at law.
 Enforceable at law means that if the agreement reached
between the parties breached (deviations occur from the
promises) by one of the parties, the aggrieved party, may
bring a legal action against the other to demand the
enforcement of its rights with the support of law.
 A valid contract is an agreement made between two or
more parties whereby legal rights and obligations are
created which the law will enforce.

 The earliest recorded reference to a building contract

comes from one of the laws of Hammurabi, the
Babylonian conqueror:
“If a contractor builds a house for a man this man shall
give the contractor two shekels of silver as recompense.
If a contractor builds a house and does not build it
strong enough and it collapses and kills the owner the
contractor shall be put to death.”
 This ancient law explicitly express the rights, obligations

and penalties for non compliance of contracting parties.

 According to Art. 1675 of the 1960 Civil Code of
Ethiopia:
“A contract is an agreement whereby two or more
persons as between themselves create, vary or extinguish
obligations of a proprietary nature.”
 The definition encompass the following main points:
 The contract is an agreement;
 The agreement is to be made between two or more
persons;
 The agreement is binding between such two or more
persons;
 The agreement is to create, vary and extinguish
obligations;
 The nature of obligations is proprietary.

Legal Perspective
 According to Art. 1678 of the Civil Code, no valid
contract shall exist unless:
 The parties are capable of contracting and give their
consent sustainable at law.
 The object of the contract is sufficiently defined and
is possible and lawful.
 The contract is made in the form prescribed by law.
 The following are the fundamental elements of contract.
 Capacity of the contracting parties;
 Consent of the contracting parties;
 Object of the contract; and
 Form of contract, if any.

2.1 Capacity
 According to Art. 1678 (a) of the Civil Code, Capacity

refers to competence to enter in to a legally binding
agreement.
 Parties entering in to an agreement or contract shall,
therefore, be capable of contracting.
 Legal capacity is of two types.
 Personal (Own) capacity,
 Representative (Agent) capacity.

2.1 Capacity
 The following may not have legal capacity to enter in to
contract and bind themselves.
 Minors (under the age of 18);
 Companies adjudged or declared bankrupt;
 Judicially interdicted persons;
 Legally interdicted persons;
 Persons, whose civil rights are suspended by the
judgment of the court;
 Non-nationals, unless permitted by law or special
prerogative.

2.2 Consent
 Consent is thoroughly dealt with in the civil code, (Art.
1678 (a) and Art. 1679- Art. 1710)
 Consent is a declared will of the individual to enter in to
contract.
 It is the willingness of the parties to enter in to a legally
binding relation.
 Consent of the intended contracting parties decomposes
in to:
 Offer, and
 Acceptance.

2.2 Consent
2.2.1 Offer
 Offer is a proposal expressing the declared willingness of
the offeror to enter in to an agreement, if the offer is
accepted.
 Offer is a legal process which is a declaration of
willingness or intent to be bound by specific terms set
out.
 A valid offer shall be:
 Certain,
 Communicated,
 Unconditional,
 Distinguished from invitation to treat (display of
goods, advertisement, tender etc.).
2.2 Consent
2.2.2 Acceptance
 Acceptance is a declaration of will to enter in to a legally
binding contract.
 By acceptance, a contract shall be completed, where the
offeree accepts the offer without any reservation.
 Characteristics of Acceptance:
 Acceptance could be conditional or unconditional.
 Conditional acceptance rejects the original offer made by the
bidder (offeror) and creates a counter offer or new offer by the
project owner.
 Unconditional or unreserved acceptance of an offer by the
project owner creates a Contract Agreement between the
bidder and the project owner subject to other subsequent
actions, such as negotiation.
 In case of Public Projects, approval of the Contract by higher
authorities may be required. In that case, legally, the Contract is
not yet concluded until the required approval is secured.
2.3 Object of Contract
 The object of contract is the very obligations of the
contracting parties i.e. in the construction contract, the
obligations of the employer and of the contractor (Art.
1678 (b) and Art. 1711 – Art. 1718 of the Civil Code).
 The possible objects, i.e. the obligations of the
contracting parties, of contract include:
 obligation to do (to perform),
 obligation not to do, or
 obligation to deliver.
 The obligations of the contracting parties could be
divided in to two broad terms:
 Promises, and
 Considerations.

2.3 Object of Contract
 The object of contract (both promises and considerations)

shall be:
 Sufficiently defined: Art. 1678(b) cum Art. 1714,
 Possible: Art. 1678(b) cum Art. 1715,
 Lawful: Art. 1678(b) cum Art. 1716(1),
 Not immoral: Art. 1716(1).

2.4 Form of Contract
 Form refers to the types of contract. Form may also mean
the making of the contract orally or in writing (Art. 1678
(c) cum Art. 1719 – Art. 1730 of the Civil Code).
 Should the contract is to be made in certain prescribed
form, it means that contract should be made in writing.
 In this case, form is related with the validity and proof of
the contract itself.
 Contracts with public (government) body shall be made,
legally, in writing (Art. 1724 of the Civil Code).
 If the contract shall be made in writing, there are two
possibilities:
 Preparing fully tailor-made contract to the project at hand; or
 Using standard conditions of contract suitable for the project at
hand;
 Effects of contract may have two dimensions:

 The time when the contract is considered bound by
the contracting parties; and
 The fulfillment or performance of the set of
promises prescribed in the contract;
 The first one relates to the effectiveness of the contract,
whereas the second is related to the performance of
obligations of the contracting parties under the contract.

3.1 Effectiveness of Contract (Time)
 This may be expressed in the following three ways:
 Contract is effective and thus is binding on the
contracting parties from the moment of the
conclusion of the contract;
 Contract can be considered effective after some days
are passed from the conclusion of the contract; and
 Contract can be considered effective after the
performance of some actions by the contracting
parties; such as:
o Making advance payment a condition
precedent for the effectiveness of the contract;
o Securing approval of the contract by higher
authorities; and
o Other pre-conditions.
3.2 Performance of Contract (Discharge)
 Performance of Contract is the carrying out or discharge
of the obligation under taken by the contracting parties.
 It focuses on the real performance of the contract as
agreed.
 This concept is related to the Latin maxim: pacta sunt
servanda one who enters into a contract is legally bound
or agreement to be kept.
 Effects of contract may bring:
 Contractual effects, and /or
 Legal effects.

4.1 International Context
 Construction Contract, according to the 1996 Housing
Grants, Construction and Regeneration Act (of England),
includes any agreement in writing, or evidenced in
writing, under which a party does any of the following:
 Carries out construction operations;
 Arranges for others to carry out construction
operations (such as, through sub-contracts);
 Provides labor for the carrying out of construction
operations.
 According to the Act, construction operations extends
beyond construction itself to works of alterations, repair,
maintenance, decoration and demolition, and even to
cleaning carried out in the course of such works.

4.1 International Context
 Construction operations cover not only structures but
also the installation of services and ancillary works such
as site clearance, excavation, scaffolding, site restoration
and landscaping.
 The said Act, however, specifically excludes mining
works and the installation or demolition of plant or
machinery for the process industry.
 A construction contract is a product of an agreement
between the Employer and the Contractor.
 Construction contract could be:
 Private or public in terms of ownership;
 Local or international in terms of the nationality of
parties;
 Purely construction or mixed with industrial works in
terms of scope of the construction works involved.
4.2 Ethiopian Context
 Construction contract is legally designated as contract of

work and labor in Ethiopia.
 A contract of work could, be private or public works.
 According to Art. 2610 of the Civil Code, a contract of
(private) work and labor is defined as follows:
“A contract of work and labor is a contract whereby one
party, the contractor, undertakes to produce a given
result, under his own responsibility, in consideration of a
remuneration that the other party, the client, undertakes
to pay him.”

4.2 Ethiopian Context
 According to Art. 3244 of the Civil Code, contract of

public works is defined as follows:
“A contract of public works is a contract whereby a
person, the contractor, binds himself in favor of an
administrative authority to construct, maintain or repair
a public work in consideration of a price.”
 Contract of public works is governed by a special regime
of law known as the law of administrative contract (Art.
3131 ff. of the Civil Code).

4.3 Purpose of Construction Contracts
 The fundamental purpose of construction contract is to:
 Describe scope of work;
 Establish time frame;
 Establish cost and payment provisions;
 Establish commercial terms and conditions;
 Set obligations, remedial rights and relationships;
 Balance risk;
 Set project execution plan;
 Minimize disputes; and
 Improves economic return of investment.

4.3 Components of Construction Contracts
 The typical contract documents in a given large and
complex construction contract include the following
components; legal, commercial, technical and
technological parts.
A. Legal Part
 The Contract Agreement;
 Minutes of Meeting, if any;
 Letter of Acceptance(Award), if any;
 The Tender ( NB: Including the Appendix to Tender,
if any);
 Special Conditions of Contract;
 General Conditions of Contract;
 Others, if any.
B. Commercial Part
 Performance Security Form;
 Payment Security Form;
 Advance Payment Guarantee Form;
 Bid Security Form;
 Insurance Forms;
 Retention Money Security Form;
 Others, if any.

C. Technical Part
 Technical Specifications,
 Drawings,
 Bill of Quantities, BOQ
 Schedule of Requirements, if any,
 Others, if any.
D. Technological Part
 It is vital in relation to some process aspect of the
construction project, if any;

4.4 Parties to Construction Contracts
 The formal parties to the construction contract are
basically the Contractor and the Employer.
 The Contractor could be:
 General contractor or joint venture i.e. in terms of its
organizational form;
 Domestic/local or foreign/international i.e. in terms of its
nationality;
 Private or public i.e. in terms of its type of ownership;
 Only constructor or both designer and contractor, or
designer, contractor and financier, or management
contractor, build operate transfer (BOT), or build, own,
operate and transfer (BOOT): i.e. in terms of assumed
contractual obligation;
 Specialty contractor; in terms of its organizational
competence; This is specially valid for sub-contractors.
4.4 Parties to Construction Contracts
 The Employer could be:
 Natural person or a legal person.
 Legal persons could be:
o Government;
o Non-governmental organizations (NGOs);
o Private entities;
o Community Based Organizations (CBOs);
o Cooperatives;
o Professional and other associations; and
o Other forms of legal incorporation.

 Construction contracts are classified on the basis of
payment methods (fixed price or cost plus fee) adopted
by the employer/client/owner/promoter.
 Construction contracts take the following forms:
 Competitive (fixed price) contract:
o Lump Sum, and
o Unit price/Ad-measurement.
 Negotiated (Cost plus) contract:
o Cost plus fixed fee,
o Cost plus fixed percentage,
o Cost plus variable fee,
o Target cost/estimate, and
o Guaranteed maximum price.

 The following factors affect the choice of specific type of
contract:
 Nature and complexity of the works;
 Size and duration of contract;
 Degree of definition (scope, risk, uncertainty);
 Status of design;
 Technical/Supervisory resource of Employer;
 Budgetary/Financing/Borrowing constraints;
 Previous experience of Employer; and
 Standard documents of funding agency.

5.1 Fixed Price Contract
 Fixed Price types of contract are ones wherein a
contractor agrees to furnish services and material at a
specified price, possibly with a mutually agreed upon
escalation clause.
 This type of contract is most often employed when the
scope of services to be provided is well defined.
 The two forms include:
 Lump sum contract (Buildings),
 Unit price contract (heavy construction).

5.1.1 Lump Sum Contract
 In this type of contract, a single lump sum price is quoted
for the completion of the specified work to the
satisfaction of the employer within a certain duration.
 The contractor offers to do the whole work as shown in
drawings and described by specifications, for a total
stipulated sum of money.
 For such contracts, the design must be complete and
final, as there is no mechanism within the contract for
adjustment of the price in consequence of variation.
 The contractor bears high risk.

Suitability
 A lump sum contract is more suitable for works for
which contractors have prior construction experience.
 The experience enables the contractors to submit a more
realistic bid.
 This type of contract is not suitable for difficult
foundations, excavations of uncertain character, and
projects susceptible to unpredictable hazard and
variations.

Merits
 The owner decides whether to start or leave the project
knowing the total lump sum price quoted by different
contractors.
 The contractor can earn more profit by in-depth
planning and effective management at site.
 Contractor will assign best personnel.
 Contractor selection is easy.

Demerits
 Before the contract is awarded, the project has to be
studied thoroughly and the complete contract document
has to be prepared in advance.
 Unforeseen details of work are not specified in the
contract document.
 Many additional items may have to be undertaken as the
work progresses, giving opportunity to the contractor for
claiming higher rates for the extra items not included in
the contract agreement; hence, changes are difficult and
costly.
 Contractor is free to use the lowest cost of material
equipment, methods etc.
5.1.2 Unit Price/Ad-measurement Contract
 The contractor execute the work on an item rate basis.
 The amount to be received by the contactor depends upon
the quantities of various items of work actually executed.
 Used for works where it is impossible to calculate in
advance the exact quantity of materials that will be
required; hence, require sufficient design definition to
estimate quantities of units.
 Time and cost risk is shared by contracting parties.
 Owner: at risk for total quantities
 Contractor: at risk for fixed unit price.
 Large quantities changes (>15-25%) can lead to increase
or decrease of unit price.
Suitability
 The item rate contract is most commonly used for all types of
engineering works.
 This type of contract is suitable for works which can be
divided into various items and quantities (WBS), where each
item, can be estimated with accuracy.
Merits
 There is no need for detailed drawings at the time of allotting
contract as in the case of lump sum contract. The detailed drawings
can be prepared after the contract is awarded.
 Changes in drawings and quantities of individual items can be
made as per requirement within agreed limits.
 The Payment to the contractor is made on the actual work done
by him at the agreed rates.
Demerits
 The total cost of work can only be known upon
completion.
 As such the owner may incur financial difficulty if the
final cost increases substantially.
 Additional staff is required to take detailed measurements
of work done for releasing payments to the contractor.
 The scope for additional saving with the use of inferior
quality materials may prompt the contractor to use such
materials in the work.

5.2 Negotiated Contract
 Cost plus (cost reimbursable) contracts are used in
situations that make it difficult or impossible for either
the owner or the contractor to predict their costs during
the negotiation, bid, and award process.
 The contractor agrees to furnish to the client services and
material at actual cost, plus an agreed upon fee for these
services.
 This type of contract is employed most often when the
scope of services to be provided is not well defined.
 By using this type of contract the contractor can start
work without a clearly defined project scope, since all
costs will be reimbursed and a profit guaranteed.

 Actual cost plus a negotiated reimbursement to cover
overheads and profit with different methods of
reimbursement:
 Cost plus fixed fee,
 Cost plus fixed percentage,
 Cost plus variable percentage,
 Target cost/estimate,
 Guaranteed maximum price.
 It is applied for complex projects such as: power plants,
tunnels, process plants etc.

5.2.1 Cost plus Fixed Fee Contract
 Cost plus fixed fee contract is desirable when the scope and
nature of the work can at least be broadly defined.
 The amount of fee is determined as a lump sum from a
consideration of the scope of work, its approximate cost,
nature of work, estimated time of construction, manpower
and equipment requirements etc.
 In order to negotiate such a type of contract, it is essential
that the scope and some general details of the work are
defined.
 The contractor have incentive to complete the job quickly
since its fee is fixed regardless of the duration of the project.
 The owner assumes the risks of cost overrun while the
contractor may risk the erosion of its profits if the project
is dragged on beyond the expected time.
Suitability
 This type of contract is suitable for works required to be
completed expeditiously and where it is difficult to
foretell what difficulties are likely to be encountered.
 This contract is also suitable for important projects,
where the cost of construction is immaterial.

Merit
 In this type of contract, actual cost is to be borne by the
owner. Therefore, the contractor performs the work in the
best interest of the owner resulting in good quality work.
 The work can be taken ahead even before the detailed
drawings and specifications are finalized.
 Changes in design and method of construction if needed
can be easily carried out without disputes.
 Provides incentive i.e. the work can be executed speedily.
 Fee amount is fixed regardless of price fluctuation.

Demerit
 This form of contract cannot be adopted normally in case
of public bodies and Government departments.
 The final cost of the work is not known in advance and
this may subject the owner to financial difficulties.
 Expensive materials and construction techniques may
be used to expedite construction.

5.2.2 Cost plus Fixed Percentage Contract
 In this type of contract, the contractor is given a certain
percentage over the actual cost construction.
 The owner is forced to assume all risks of cost overruns.
 Furthermore, if there are pressing needs to complete the
project, overtime payments to workers are common and
will further increase the project cost.
 Unless there are compelling reasons such as the urgency
in the construction of military installations, the owner
shouldn’t use this type of contract.
 The suitability, merits and demerits of this type of
contract are similar to cost plus fixed fee contracts.
 An additional demerit is the tendency of the contractor to
increase the cost of work to earn more profit by way of
percentage of enhanced actual cost.
5.2.3 Cost plus Variable Percentage Contract
 For this type of contract, the contractor agrees to a
penalty if the actual cost exceeds the estimated project
cost, or a reward if the actual cost is below the estimated
project cost.
 In return for taking the risk on its own estimate, the
contractor is allowed a variable percentage of the direct
project cost for its fee.
 Furthermore, the project duration is usually specified and
the contractor must abide by the deadline for completion.
 This type of contract allocates considerable risk for cost
overruns to the owner, but also provides incentives to
contractors to reduce costs as much as possible.

5.2.4 Target Cost/Estimate Contract
 This is another form of contract which specifies a penalty
or reward to a contractor, depending on whether the
actual cost is greater than or less than the contractor's
estimated direct project cost.
 Usually, the percentages of savings or overrun to be
shared by the owner and the contractor are predetermined
and the project duration is specified in the contract.
 Bonuses or penalties may be stipulated for different
project completion dates.

5.2.5 Guaranteed Maximum Price Contract
 When the project scope is well defined, an owner may
choose to ask the contractor to take all the risks, both in
terms of actual project cost and project time.
 Any work change orders from the owner must be
extremely minor if at all, since performance
specifications are provided to the owner at the outset of
construction.
 The owner and the contractor agree to a project cost
guaranteed by the contractor as maximum. There may be
or may not be additional provisions to share any savings
if any in the contract.
 This type of contract is particularly suitable for turnkey
operation.
THANK YOU!

4.2 Contracts

Uploaded by

Copyright:

Available Formats

You might also like

4.2 Contracts

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

4.2 Contracts

Uploaded by

Copyright:

Available Formats

School of Civil and Environmental Engineering

CENG 5104: CONSTRUCTION MANAGEMENT

AAU, AAiT, Construction Management, 2020, Fasil T.

 Generally, a contract is an agreement or willful promise

AAU, AAiT, Construction Management, 2020, Fasil T.

 The earliest recorded reference to a building contract

 This ancient law explicitly express the rights, obligations

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

 According to Art. 1678 (a) of the Civil Code, Capacity

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

 The object of contract (both promises and considerations)

AAU, AAiT, Construction Management, 2020, Fasil T.

 Effects of contract may have two dimensions:

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

 Construction contract is legally designated as contract of

AAU, AAiT, Construction Management, 2020, Fasil T.

 According to Art. 3244 of the Civil Code, contract of

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

AAU, AAiT, Construction Management, 2020, Fasil T.

You might also like