PRE-CONTRACT ADMINISTRATION (DQS259)

TOPIC 2

CONSTRUCTION CONTRACT

1.0 Definition of Contract

Contract can be defined as “An agreement, enforceable by the law, between two or
more persons to do or abstain some act, their intention to create legal relations, both
having promise to give something of value as consideration for any benefit derived
from the agreement” or “an agreement and comes into existence when one party
makes offer, which the other accepts.”

2.0 Basic Elements of Contract

i) Firm offer
ii) Unqualified acceptance
iii) Consideration
iv) Intention to create legal relations
v) Free consent
vi) Certainty of terms
vii) Lawful object and consideration
viii) Legal Capacity to contract
ix) Physical/legal possibility
x) Valid/Enforceable agreement

The basic elements which are necessary for the creation of a legally binding and
enforceable contract are:

i) A clear or firm offer or proposal

ii) An unqualified acceptance of the offer/proposal
iii) Intention to create legal relations – both parties must show an intention to enter
into a legally binding agreement
iv) Consideration – each party must contribute something in reciprocation of the
other’s promise
v) Certainty – the terms of an agreement must be certain or capable of being
made certain.
vi) Capacity – the parties must have a legal capacity to contract
vii) Consent – the parties must contract with free consent (i.e fraud, undue
influence)
viii) Legality – the contract must be form within the boundaries of the law.

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ix) Possibility – the contract must be capable of performance both physically and
legally.

3.0 Types of Contract

Types of contract can be divided into 2 categories:

1) Contracts based on the pricing / payment criteria

o Fixed price
▪ Lump sum contract
• With quantities
• With drawings and specification
▪ Measure and value contract
• Based on approximate quantities
• Based on schedule of rates

o Cost reimbursement
▪ Cost plus fixed fee
▪ Cost plus percentage fee
▪ Target cost

2) Contracts based on the method of contract procurement

4.0 Contracts based on the pricing / payment

4.1 Fixed price - lump sum contract with quantities

• The client appoints an architect to prepare a design & the QS prepares a BQ based
on the drawing and specification.
• Contractor are invited to price the bills and submit tenders & awarded to the
selected tenderer.

4.1.1 Characteristics:
i) Both the quantities & the unit rates in the bill form part of the contract.
ii) Virtual completion of the design precedes the signing of the contract

4.1.2 Advantages:
i) Both parties have a clear picture of the extent of their respective commitments
ii) The units rates in the BQ provide a sound basis for the valuation of V.O.
iii) A detailed breakdown of the tender sum is readily available.

4.1.3 Disadvantages:
i) The length of time taken in the design & bill of quantities preparation.

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4.2 Fixed price – lump sum contract with drawings and specification

• No BQ are supplied to the tenderers. They have to prepare their own quantities
from the drawings provided.

4.2.1 Characteristics

i) Tenderers are supplied only with complete working drawings and full
specification
ii) Virtual completion of the design precedes the signing of the contract

4.2.2 Advantages

i) The time required for preparation of tender document is reduced as the process
of preparing BQ is eliminated
ii) Both parties can have a clear picture of their respective commitments when
signing the contract.

4.2.3 Disadvantages

i) No breakdown of the tender sum is immediately available

ii) The valuation of V.O presents problems.

4.3 Measure and value - based on bills of approximate quantities

• The quantities given in the bill are approximate only & subject to re-measurement.

4.3.1 Characteristics

i) Only the unit rates form part of the contract.

ii) The signing of the contract & the beginning of work on site may proceed before
the design is complete.

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4.3.2 Advantages

i) Construction on site may begin earlier.

ii) The extra expenses of preparing firm quantities are avoided but this will offset
by the cost of doing re-measurement.

4.3.3 Disadvantages

i) The BQ cannot be relied upon as giving a realistic total cost at tender stage.
ii) Re-measurement works may prove to be more costly than preparing BQ
initially.

4.4 Measure and value - based on schedule of rates

• The quantities given in the bill are approximate only & subject to re-
measurement.
• Tenders being based upon schedule of rates.

4.5 Cost reimbursement contract

• Also known as prime cost/cost plus because the method of payment is by

reimbursement to the contractor of his prime cost plus a management fee.
• No site measuring is necessary. The process of calculating & verifying the total
prime cost involves investigation & checking of invoices, time sheets, sub-
contractor’s accounts etc.

4.5.1 Advantages

• The time required for preparation of tender document and for obtaining tenders
is minimized. Early start on site to be made.
• Work on site may proceed before the detailed design is complete.

4.5.2 Disadvantages

• The parties have least indication of their commitments.

• Cost of construction to the client is greater

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• The computation & verification of the total prime cost is a long and tedious
process.

This type of contract is the m ost uneconomical type of contract & should only be used
in certain circumstances i.e where cost is less important factor than time. There are
three types of cost reimbursement:

1) Cost Plus Percentage Fee

2) Cost Plus Fixed Fee
3) Target Cost

1) Cost plus percentage fee

The contractor is paid a fee equal to an agreed % of the prime costs. The fee paid to
the contractor is a fixed sum which normally vary with the total prime cost.

Example :

Total prime cost RM50,000.00

15% addition for overheads RM7500
5% addition for profit RM2500 RM10,000.00
Total cost of contract RM60,000.00

Due to uneconomic organization of the contract, inefficiency & excessive waste, the
total prime cost was RM 55,000.00 (excess of RM5,000) then the total cost would be:

Total prime cost RM55,000.00

20% addition for overheads
and profit RM11,000.00
Total cost of contract RM66,000.00

The contractor’s overheads still RM7500 but the profit would be RM3500 (RM11,000
– RM7500).
(The more inefficient the contractor’s operations, the greater the waste of resources,
the higher the fee paid to the contractor. The more disinfective to the contractor to work
efficiently)

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2) Cost plus fixed fee

The fee paid to the contractor is a fixed sum which normally does not vary with the
total prime cost.

Example :

Total prime cost RM50,000.00

Overheads RM7500
Profit RM2500 RM10,000.00
Total cost of contract RM60,000.00
O/head = 15%, Profit = 5%
Due to uneconomic organization of the contract, inefficiency & excessive waste, the
total prime cost was RM 55,000.00 (excess of RM5,000), then the total cost would be:

Total prime cost RM55,000.00

Fixed overheads
and profit RM10,000.00
Total cost of contract RM65,000.00

O/head = 14%, Profit = 4.5%

3) Target cost

As an incentive to reduce the prime cost, the agreement provides

• bonus to be paid to the contractor if the total prime cost < the agreed sum
(target cost).
• Penalty to be paid by the contractor if the total prime cost > the target cost.
• The bonus & penalty are commonly 50% of the difference between the total
amounts. Under this contractual arrangement, an extra cost/saving is shared
between the client & the contractor.

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Example 1:

Original prime cost RM 50,000.00

Excess RM 5,000.00
Target Cost RM 60,000.00

Total prime cost RM 55,000.00

Fixed Fee RM 10,000.00
Ddt penalty, being 50% of
Excess over RM 60,000.00
(target cost) RM 2,500.00
Amount of Final Payment RM 62,500.00

Total Fee = RM 10,000.00 – RM 7,500.00 (Just enough for overhead….& no profit )

Example 2:

Original prime cost RM 50000.00

Saving RM 2,000.00
Target Cost RM 60,000.00

Total prime cost RM 48,000.00

Fixed Fee RM 10,000.00
Add bonus, being 50% of
Saving over RM 60,000.00
(target cost) RM 1,000.00
Amount of Final Payment RM 59,000.00

Total Fee has increased RM 11,000.00 including RM 7,500.00 for overhead & RM
3,500.00 (7.3%) for profit.

5.0 Application of Contract

5.1 Based on bills of quantities

• Enough time to prepare a complete design to be measured by the QS

• When the Client's total commitment must be known beforehand

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5.2 Based on approximate quantities

• When the design is complete but insufficient time to taking off or the design is
not complete to do taking off
• When it is desired to have the advantages of detailed bills without the cost in
terms of time

5.3 Based on drawings and specifications

• When the project is small

• When time is short & client considers it to be less important to have BQ than
the early completion

5.4 Based on schedule of rates

• When the details of the design have not yet been worked out
• Time is pressing

5.5 Based on prime cost plus fee

• Time is short & cost is not as important as time

• When the client wishes to use a contractor who has worked satisfactorily for
him & prepared to pay higher cost.
• For emergency / maintenance & alteration works where there is insufficient time

6.0 Risk Allocation

Occasionally, more than one type might be suitable. The one which seems to offer the
greatest benefits to the client should be chosen.
The risk allocation,

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