Construction Contract Administration (CON3372)

Chapter 2 – Contract Arrangement

1. Types of Contract

Contracts for the execution of construction works may be broadly classified as

follows.

1.1 Lump Sum Contracts

Definition: In a lump sum contract, the contractor undertakes to carry out certain
specified works for a fixed sum of money, subject to the possible increases or
decreases as a result of variations ordered by the Engineer.

The nature and the extent of the works are normally indicated on drawings and the
nature of the materials and workmanship described in a specification.

1.1.1 Lump Sum Without Quantities (Based on Drawings & Specification)

In lump sum contracts based on plan and specification, the contractor undertakes to
carry out the work described, or specified, to completion, for an agreed lump sum.

The documents required for this contractual arrangement are the complete working
drawings, together with a full specification.

No bills of quantities are supplied to the tenderers who must prepare their own
quantities from the drawings.

There are substantial risks imposed on the tenderers under this arrangement. A
tenderer is responsible for any errors he makes in the taking off from the drawings.

The contractor is required to take up all responsibilities for any costs incurred due to
uncertainties or unforeseen difficulties when preparing the tender.

In order to allow for these risks, the tenderers are likely to include higher cost in their
prices.

©VTC2017 Page 1 of 14
Construction Contract Administration (CON3372)

Since there are substantial risks imposed upon the contractor, this contractual
arrangement is suitable for the following circumstances:

- Minor works where the likelihood of variations is small and,

- The amount of information to be supplied during the progress of the work is
minimal.

Advantages

- The time for the preparation of tender documents is reduced, as the time
consuming process of preparing bills of quantities is eliminated.
- As it is a lump sum contract, both parties can have a clear picture of their
respective commitments at the time of signing the contract.

Disadvantages

- No breakdown of the tender sum is available

- The cost to the tenderers of producing their own quantities will be reflected in a
higher tender prices.

1.1.2 Lump Sum With Quantities (Based on Bill of Quantities)

This type of contract, which incorporates a bill of quantities priced by the contractor,
where the quantities of the bulk of the work can be ascertained with reasonable
accuracy before the work is started.

An example of item in a bill of quantities is as follow:-

Description Quantity Unit Rate Total

Blinding concrete grade 10/20 20 m³ $900/m³ $18,000.00
Ordinary Portland Cement

The tender sum is derived from the total of the items in the bill of quantities.

In lump sum contracts based on bill of quantities, the contractor undertakes to carry
out the work in accordance with the drawings, specification and as described in the
bill of quantities for a lump sum.

©VTC2017 Page 2 of 14
Construction Contract Administration (CON3372)

This type of contract is suitable for the following circumstances:

- The nature of this form of contract requires a full comprehensive design from the
Engineer and requires the variations and additional information be kept to a
minimum.

- In cases where early start of work is desired or where the extent of work is
uncertain or substantial variations are expected, the use of bills of quantities is
restricted.

Advantages

- The design team has to finalize the design requirement as much as practicable
before committing into a lump sum contract. As a result, the employer and the
contractor enter the contract with their commitments clear.

- The employer’s quantities surveyor prepares the bills of quantities from the
drawings, which the competing contractors will price on the same set of
information. It provides a fairer basis for competition.

- It gives the employer a good indication of the final cost of the work.

- The quantities and the unit rates of the measured items will serve as the basis for
the valuation of variation when there are changes to the works.

Disadvantage

- The longer length of time taken in the design of the project and preparation of the
bills of quantities.

©VTC2017 Page 3 of 14
Construction Contract Administration (CON3372)

1.2 Measurement Contracts

Definition: In measurement contracts, the contract sum is ascertained by measurement

and valuation related to bills of approximate quantities or to a schedule of rates
included in the contract.

1.2.1 Measurement Contract based on Bills of Approximate Quantities

This method is similar to the one of the Bills of Quantities, except that the quantities
given in this bill are approximate only and are subject to a remeasurement once the
works are completed.

An item of a bill of approximate quantities is as follow:-

Description Quantity Unit Rate Total

Blinding concrete grade 10/20 20 m³ $900/m³ $18,000.00
Ordinary Portland Cement (Approximate qty)

In measurement contracts based on bills of approximate quantities, the contractor

carries out the work required, which is then priced at the rates in the bill of
approximate quantities. The final quantities shall be remeasured.

The approximate quantities included in the contract are subject to remeasurement of

completed work during the progress of the contract.

Only the unit rates form part of contract and work on site may proceed before the
design is completed.

This type of contract arrangement is used for the following circumstances:-

- where the employer cannot determine his requirements in advance, or

- where the urgent nature of the project does not allow adequate time for design and
firm quantities to proceed tendering.

©VTC2017 Page 4 of 14
Construction Contract Administration (CON3372)

Advantages

- Approximate bills permit the overlapping of design and construction and this will
save time before tendering.

- Approximate bills avoid the great expense of preparing firm quantities, in

particular, where there may be substantial variation works.

Disadvantages

- The bills of quantities cannot be relied to give realistic total cost at tender stage as
the quantities are approximate.

- Where the bills are too approximate, for example, where the uncertainty as to the
character of the work is too vague, the usefulness of the bills will be reduced.

1.2.2 Measurement Contract based on a Schedule of Rates

In measurement contracts based on a schedule of rates, the contractor carries out the
work required, which is then measured and priced at the rate in a schedule of rates.

This type of contract arrangement is used where the employer cannot determine his
requirements in advance. Commonly used in maintenance work such as concrete
repair work.

This type of contract arrangement may take one of two forms:

The employer may supply a schedule of unit rates. The schedule consists of a list of
measured items with units of measurement stated against each, but with no quantities
given. The contractors, when tendering, is required to state a percentage above or
below the given rates.

©VTC2017 Page 5 of 14
Construction Contract Administration (CON3372)

An item of a standard schedule of rate is as follow:-

Description Unit of Measurement Unit Rate % Adjustment

In-situ concrete m³ $800/m³ (+15%)
Grade 30/20
Ordinary Portland Cement

Alternatively, a schedule of rates may be specially prepared and only the items
relevant to the job in question will be written into the schedules; these schedules are
known as ad-hoc schedule. They should contain as many items as practicable so that
the fixing of rates on varied work will be easier.

The contractors may be requested to insert prices against each item of work, and a
comparison of the prices entered will enable the most favorable offer to be
ascertained.

An item of an ad-hoc schedule of rate is as follow:-

Description Unit of Measurement Unit Rate

In-situ concrete m³ $950/m³
Grade 30/20 (inserted by the contractor)
Ordinary Portland Cement

Advantages

- It allows for contract to be signed and work to start on site when design is in
preliminary stage and shorten the pre-contract period.

- The use of standard schedule of rates eliminated the need for lengthy tendering
time.

Disadvantages

- The schedule of rates comprises components of work without any quantities. This
leads to difficulty in quoting realistic prices, resulting in greater risk to both the
client and the contractor.

©VTC2017 Page 6 of 14
Construction Contract Administration (CON3372)

1.3 Cost Reimbursement Contract

In cost reimbursement contracts, the price to be paid is determined on the basis of the
actual cost or prime cost incurred by contractor in carrying out the work such as the
- Cost of Material
- Cost of Labour
- Cost of Plant
(+) an agreed amount to cover Profit & Overhead.

Of all contracts, this type involves the most uncertainty as to the financial outcome.
Tenders contain no total sum and it may be very difficult to form any reliable estimate
of the total cost.

It should be noted that no measurement is necessary other than checks on the

quantities of materials for which the contractor submits invoices, time sheets,
subcontractors’ account, etc.

This is used in the following circumstances:-

- Where the requirements are only in general terms because of the nature of the
work, such emergency repair of damage, and/or of the shortage of time.

- It is used for construction of an unusual nature, where requirements cannot be

ascertained before the contract is let, and where it is not possible to make any
estimate or the total final cost.

©VTC2017 Page 7 of 14
Construction Contract Administration (CON3372)

1.3.1 Cost Plus Percentage

The contractor carries out the work and is paid all Prime Costs plus a Fee for profits
and overhead, calculated as a percentage of the total cost.

“Prime Cost + (%) for Profit & Overhead”

There is no financial incentive to encourage the contractor to carry out the work
economically. The contractor may even be inclined to make the cost as great as
possible in order to earn a higher level of overheads and profit.

Advantages

- Once the basis of the contract is agreed the work can commence immediately, thus
avoiding the delay which is necessary if estimates have to be prepared.

- The contractor is efficient, so the cost to the employer should represent a fair price
for the work undertaken.

Disadvantages

- It is difficult to predict the final cost at the early stage of the work.

- Some form of control is necessary in order to ensure that the correct costs are
being charged by the contractor, and such a control system may be difficult and
costly.

©VTC2017 Page 8 of 14
Construction Contract Administration (CON3372)

1.3.2 Cost Plus Fixed Fee

This may be used where an accurate estimate of the maximum total final cost can be
made.

The fee for the overheads and profit will be agreed as a fixed sum unless the scope of
work has altered after the contractor has tendered.

“Prime Cost + A Fixed Amount for Profit & Overhead”

Since the fee is fixed and will not be affected by the costs, the contractor may try to
reduce the time, and thus the cost of the construction. This will result is a saving to
the employer.

Advantages

- The advantage of speed in commencing the work is undermined, since a fairly

detailed scheme of work must be prepared before a fee can be agreed.

Disadvantages

- If there are any major variations, which can be difficult to avoid in this type of
work, then the fee must be re-negotiated to take account of such variation.

©VTC2017 Page 9 of 14
Construction Contract Administration (CON3372)

1.3.3 Target Price

The employer’s requirements must be known in some detail, and it must be possible
to prepare a reliable estimate of the probable cost.

Under this arrangement, a target price is agreed for the work. The contractor is
reimbursed in the first place on the basis of cost plus percentage or fixed fee.

Then as an incentive to reducing the prime cost, the agreement provides for a bonus to
be paid to the contractor if the total cost is less than the agreed target cost and also a
penalty is to be paid by the contractor if the total cost exceeds that sum.

This method provides an effective incentive for the contractor.

The target price must be fixed accurately, and the extent of work to be carried out
must be well defined.

Extensive negotiation between the employer and the contractor should take place in
order to arrive at a realistic target price.

The target price must be kept constantly under review throughout the progress of the
contract and amended for the value of any variations required by the employer.

©VTC2017 Page 10 of 14
Construction Contract Administration (CON3372)

1.4 Management Contract

The management contractor is employed to manage, coordinate and direct the work of
other contractors on behalf of the employer.

The management contractor does none of the construction work himself but it is
divided into packages which are carried out by other contractors employed by the
employer.

The management contractor’s role is that of providing a construction management

service on a fee basis as part of the employer’s management team-organizing,
coordinating, supervising and managing the construction works in cooperation with
the employer’s other professional consultants.

This type of contract is most suitable when there is a fast-tracking in the works:

Fast-tracking is the arrangement where the works is separated into work packages to
enable the overlapping of design and construction. There will be separate contractors
carrying out the various work packages on site.

©VTC2017 Page 11 of 14
Construction Contract Administration (CON3372)

1.5 Design and Build Contracts

Design and Build Contract

These contracts work on the principle that the contractor will be responsible for the
design and construction of the structure.

The idea behind this arrangement is that the contractor can offer a better deal when he
is in control of all aspects of the project, and that the client does not have to employ
professional advisers.

The procedure is initiated by the employer preparing his requirements/brief. These are
then sent to a selection of suitable contractors, each of whom prepares his proposals
on design, time and cost.

However, the idea does not seem to work in its fullest sense, since clients still find it
necessary to employ a representative in order to ensure that the contractor’s work is of
an acceptable standard and that he is not over-charging.

Such representatives may take the form of an engineer to ensure the quality of
construction work and/ or a quantity surveyor to advise on and monitor costs.

Variations from the original design are discouraged and if allowed, are expensive.

This type of contract is used for the following circumstances:

- When the single point responsibility i.e. the contractor is solely responsible for the
design and the construction is required in the arrangement of the work.

©VTC2017 Page 12 of 14
Construction Contract Administration (CON3372)

1.6 Build-Operate-Transfer (BOT)

Public Sector
Globally, this is one of the most popular methods of privatizing government
infra-structure work.

Under this scheme a private sector organization, usually in the form of a

contractor-led consortium, undertakes to finance, design, construct and operate an
infrastructure facility.

The consortium usually carries out the construction with independent monitoring by a
consultant hired by the government.

Once the facility is complete, the consortium, established as a company, will operate
the facility for a period of time (anywhere from 10 to 30 years) as defined by a
concession granted by government.

Such a concession will allow the company, to charge the public for use of the facility
in order to repay loans and provide returns for investors.

At the end of the concession period, the faculty is handed back, or transferred, to the
government free of charge.

In Hong Kong, there are many examples of government infrastructure facilities which
have been successfully completed under the Build-Operate-Transfer scheme. One
such example is the Tate’s Cairn vehicular tunnel linking Shatin to North Kowloon.

In order to undertake this major project, a Japanese contractor, Nishimatsu

Construction Ltd (responsible for tunneling design and construction), formed a joint
venture with local contractor Gammon Construction Ltd (responsible for the design
and construction of the roads and buildings).

With the granting of a thirty year franchise, the joint venture established the Tate’s
Cairn Tunnel Company to operate the facility. Return on the company’s investment is
achieved by levying a toll on the public for use of the tunnel. The tunnel will be
handed back to the HK government in 2021.

©VTC2017 Page 13 of 14
Construction Contract Administration (CON3372)

Private Sector

There are examples of BOT schemes in Hong Kong which have been successfully
adopted for use in the private sector. One such example is that of the Standard
Chartered Bank who procured its new headquarters in Hong Kong, at no cost to itself,
by using a modified BOT scheme.

Under the scheme, the Bank awarded a twenty-five year sublease of the land, where
the existing headquarters stood, to Nishimatsu Property (Hong Kong). In return for
the granting of the sublease, Nishimatsu were required to pay a premium as well as
undertake to totally finance the cost of reconstruction; the Bank chose to retain its
own architect and consultant team, which Nishimatsu was required to allow for in its
price.

It was further agreed that, upon completion, Standard Chartered would have the
exclusive right to lease back 70% of the floor area, at a fixed rental, up until the
expiry of the twenty-five year sublease when the entire development would revert to
the Bank.

During the twenty-five year sublease period, Nishimatsu would have the right to rent
the remaining 30% of the building on the open market, subject only to the Bank’s
option to occupy another 15%.

The benefit of this scheme to the Bank was the opportunity to retain its liquid assets
(banker’s place greater value on cash than capital tied up in property), while
Nishimatsu gained by boosting their turnover by nearly HK$ 1 billion.

©VTC2017 Page 14 of 14