Types of Contracts

Different types of contracts are in vogue around the world. A few commonly used modes of procurement in the UK and western world are explained below.

Measurement Contract

Measurement contracts (sometimes called “re-measurement” or ‘measure and value’ contracts) contains a Bill of Quantities (BOQ) provided by the client or its consultant, can be used in situations where the design (or type of works) can be described in reasonable detail, but the amount cannot. The contractor will quote against each BOQ item and enter a unit rate or unit price to build up the total contract price on basis of those BOQ quantities. During the construction period, the actual quantity of works executed under each BOQ item will be jointly measured and valued at the quoted rate for interim payment purpose.

A measurement contract might also be appropriate on projects where the design has not been completed in sufficient detail for bills of quantities to be produced.

The actual contract sum (sometimes called the ‘ascertained final sum’) cannot be determined when the contract is entered into, but is calculated on completion, based on “re-measurement” of the actual work carried out and the rates tendered.

Measurement contracts can allow an early start on site, before design is complete, and they can allow changes to be made to the works relatively easily. However, there is inevitably some risk for the client as the cost of the works is not known. In effect, the client is taking the risk for any ‘unknowns’, and whilst this can result in competitive prices from contractors, the level of uncertainty for the client means that measurement contracts are rare other than on civil engineering projects.

Fixed Price or Lump Sum Contract

Within fixed-price or lump sum contracts, the client and contractor agree to a fixed total price per defined product or service. These types of contracts may also have financial incentives geared towards exceptional project performance or achieving/exceeding project objectives are relevant to constraints. For example, if the project were to be delivered ahead of schedule and under budget, the agreement may stipulate that a financial incentive predicated to a percentage of the total project is due to the service provider. Typically, anything within the contract deliverables that can be quantified or measured could be in scope for incentives based upon fixed-price contracts. Contractors within a fixed-price contract are legally obligated to complete contract deliverables and may be subject to financial damages if they do not meet client’s expectations. While these types of contracts can serve to benefit the client, there is the expected level of precision relative to the product or service being procured. Changes in scope relative to project expectations can be accommodated by the contractor providing the contract price is adjusted relative to agreed-upon changes.

This type of project is considered to benefit the client as the contractor assumes most of the risk. The next fixed-price contract is the fixed-price incentive fee where the fixed-price arrangement gives the client and contractor a degree of flexibility that permits for deviation from performance with financial incentives tied to achieving agreed-upon metrics. Financial incentives typically correlate to cost reductions, schedule and technical performance enhancements provided by the contractor. Milestones are typically determined at the outset of the engagement and the final contract price is determined upon completion of all work and based upon the performance of the contractor. Within fixed-price incentive fee contracts, a cost ceiling is typically agreed-upon and all costs incurred above the ceiling become the responsibility of the contractor.

Turnkey Contracts

A turnkey contract is a business arrangement in which a project is delivered in a completed state. Rather than contracting with the client to develop a project in stages, the contractor is hired to finish the entire project without client input. The contractor is separate from the final owner or operator, and the project is turned over only once it is fully operational. In effect, the contractor is finishing the project and “turning the key” over to the final owner.

This type of arrangement is commonly used for construction projects ranging from single buildings to large-scale developments.

Difference between lump-sum contract & turnkey contract:

Under a traditional lump-sum contract, the client agrees to pay the contractor to complete a project that is built to the client’s specifications. The client is given many opportunities to make decisions throughout the project, and to make changes as needed. In a turnkey contract, the client is generally left out of the building process entirely as the contractor handles all decisions and problems related to construction.

A contract of this kind may also be used in the residential home building industry. With a turnkey agreement, a builder or developer completes both the construction and the finishes in the home before turning it over to the home owner. The home owner is often offered a chance to select finishes, including curtains, paint colours and carpeting.

Cost Reimbursable Contracts

In the cost reimbursable contracts payments is made to the contractor for actual costs incurred for completed work plus an additional fee that represents the contractor’s profitability. Cost reimbursement contracts may incorporate financial incentives, whenever the contractor falls below targets or exceeds the benefits of the project deliverables. Cost reimbursable contracts provide flexibility to redirect contractor activities whenever the scope of work cannot be precisely defined at the beginning of a project. This type of contract is quite useful, if quality of project is the primary consideration. The contract can be altered as a project goes through various life cycles or when risks inherent to project deliverables change.

There are three cost reimbursable contracts most commonly used within project management. They are the cost plus fixed fee, the cost-plus incentive fee and the cost-plus award fee.

The cost-plus fixed fee contract reimburses the contractor for all allowable cost for performing contract work and contractor also receives a fixed fee payment, often calculated as a percentage of the initial estimated project cost. The fee is paid only for completed work and may not change due to contractor performance. Within this contract the amounts do not change it unless there is a change in scope aligned to the project.

The cost-plus incentive fee contract reimburses the contractor for all allowable costs for contract work and receives a predetermined incentive fee based upon achieving performance milestones set forth in the contract. If the final costs are less or greater than the original estimated cost both the client and contractor share the cost from the departure based upon pre-negotiated cost- sharing formulas. As an example, there could be an 80/20 split over or under target cost based upon the actual performance of the contractor. So, for costs in excess of the negotiated price, the contractor and client split the difference based upon a predetermined ratio.

In the cost-plus award fee contract, the contractor is reimbursed for all costs but most of the fee is earned only based upon satisfaction of subjective performance criteria defined in incorporated into the contract. In this case the determination of the fee is solely based on subjective determination of a contractor’s performance by the client.

Design and Build Contracts

Design and Build procurement works on the basis that the main contractor is responsible for undertaking both the design and construction work on a project, for an agreed lump-sum price.

Design and build projects can vary depending on the extent of the contractor’s design responsibility and how much initial design is included in the employer’s requirements. Nevertheless, the level of design responsibility and input from the contractor is much greater on design and build projects than a traditional contract with a contractor’s designed portion.

Adequate time must be allowed to prepare the employer’s requirements (the employer usually appoints consultants to facilitate this), as well as time for the contractor to prepare their proposal and tender price. It is vital that the proposal matches all of the employer’s requirements before any contract is entered into.

The employer has control over any design elements of the project that are included in their requirements, but once the contract is let responsibility over design passes to the contractor, so the employer has no direct control over the contractor’s detailed design.

The contractor can carry out the design in a number of ways. Often, they will appoint their own consultants or use their own in-house team. It is also common practice for the contractor to take on the employer’s consultants and continue to use them to complete the detailed design under what is known as a novation agreement.

Following are the few more features of D & B type contract:

• As design and construction can be carried out in parallel, the overall program time of design and build projects can be shorter. However, this depends on how much design the contractor is responsible for.
• There is reasonable certainty over costs because the contract price is known at the outset. Provided the employer does not order changes during the construction of the work, the contractor will be obliged (subject to the conditions) to complete the project for the contract sum. If the employer does require design or specification changes during the construction period, the contractor advises as to the effect this may have on costs or additional time needed.
• Design and Build is a relatively low risk procurement option for the employer, in terms of cost and time. There can be a risk related to design and quality, particularly if the employer’s requirements were not properly gathered and if insufficient time went into examining the contractor’s proposal.

Early Contractor Involvement (ECI) Contracts

The ECI contract is not so much a new form of contract but rather represents a new approach to procurement. It is a form of partnering with the contractor appointed earlier than usual to help in planning, advice on buildability and jointly develop a target cost as the basis for a pain/gain share formula.

In the context of road projects, the ECI approach involves the appointment of a contractor almost before the statutory process has started and generally prior to the publication of Compulsory Purchase Orders (CPO’s). Final road scheme details are usually not known at the time of an ECI tender but are developed through the design phase of the works.

The contractor is selected not by lowest price bid, since there is not yet design to bid for, but by an assessment of the company’s track record. The two sides then work together on an open book basis to develop a target price. The contractor is incentivised to design and construct scheme within this target price, based on a pain/gain formula.

The ECI contractor is involved in the relevant road scheme from its beginning and thereafter will work closely with the relevant authority and its consultants to develop the project. The idea is that the contractor will bring its expertise in value engineering from a very early point in the scheme’s development phase. In this context, the contractor is charged to assist the employer in promoting the scheme through the statutory process by preparing the CPO’s, the environmental impact statement and any other associated documentation and then presenting the scheme at Public Inquiries. Once the CPO’s are confirmed, the ECI contractor then carries out the detailed design for project. After assessment of the completed design against project objectives and affordability criteria, approval is issued to commence the works.

Usually, ECI is accompanied by ‘Target Pricing’. With this concept, the contractor is entitled to a share of design and construct’s savings where value engineering has facilitated reduced cost outcomes when measured against price targets fixed at different stages of the project. Such provisions are intended to incentivise the contractor’s engagement with the scheme development and maximise the benefit of early involvement. From its early days, the ECI approach has been implemented with the use of the NEC standard form of contract, which its publishers state has been drafted as ‘a modern-day family of contracts that truly embraces the concept of partnership and encourages employers, designers, contractors and project manager to work together to achieve the client’s objectives’.

The advantages of ECI type contract are:

• It enables the contractor to influence planning decisions and design development at most beneficial time.
• The process dramatically reduces the time through planning opportunities for overall project cost, and that reductions through value engineering are maximized where implemented at an early stage of the project.
• It facilitates value management and value engineering and develops best value solution.
• It minimizes claims.
• Before scheme design is finalized, the ECI contractor is provided with the opportunity to talk to organizations and people who might be affected by the scheme so that potential pitfalls and objections can be designed out. The likelihood of extended public inquiries on the scheme is significantly reduced in these circumstances.

Difference between D & B and ECI Contracts

The Design and Build (D & B) and Early Contractor Involvement (ECI) contract are close ‘relatives’, in that it exploits contractor’s unique understanding of construction process to benefit the design process. The difference is, as the name implies, that the ECI involves the contractor far earlier. Under D & B, the contractor is presented with a fixed route and a design that is at least 80% fixed. By the time the contractor comes on board, the scope for its input is limited. With ECI, the contractor joins the team right at the start of the statutory process and is involved with planning, assessing buildability and cost estimating. Though D and B like ECI works towards improving integration of design and construction, but the success of the end product often rested on how good the brief was in the first place.

PFI and PPP Contracts

'PFI' stands for 'Private Finance Initiative' and 'PPP' is shorthand for 'Public Private Partnerships'. PFI and PPP both have very similar characteristics, the key difference being the way in which the relevant project is funded.

PFI involves an infrastructure project (e.g. a hospital, health centre, school, leisure centre, social housing, street lighting, road or prison) being funded by private sector equity and debt funding and then being paid for by the public sector 'customer' through monthly payments over the life of the project. A PPP project would not necessarily require or have such private sector funding.

A good example of a PPP would be public and private sector parties setting up a joint venture company for a regeneration project, with the parties each contributing one or more of land interests, expertise/people and funding but without any set formula or structure for this.

In both PFI and PPP, the public sector client buys services with defined outputs from the private sector on a long-term basis, typically for 25 years. This will involve maintaining or constructing and maintaining the asset, and the supplier is incentivized in this model to have the highest regard to whole life costing as they have the risk of operation and maintenance for a substantial period of time.

Design Build Finance and Operate (DBFO) Contracts

DBFO type contracts are designed to create a private-sector road-operating industry and took a long-term commercial view and which might manage tolled motorways in the future. Under DBFO, the emphasis rests on the provision of an operating service rather than an asset, over long period of time, with the private sector assuming responsibility for the operation and maintenance of a length of existing (where appropriate) and for building specified improvement schemes.

(Note: The content is outcome of studying different sources)