Contracting price and costs on a project

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What form of contract and terms best suits your project? Roland Finch advises on the options, factors and issues to be considered.

There was a time when the procurement of buildings was relatively simple. Roles and responsibilities were easily understood, and the contracting procedures relatively straightforward. Perhaps the best known set of early rules is the “Code of Hammurabi”, who was a Babylonian king from around 1800BC, which included the following:

“If a builder builds a house for someone, and does not construct it properly, and the house which he built falls in and kills its owner, then that builder shall be put to death.”

In recent years, however, the process of procuring construction has become more sophisticated (and less hazardous for the participants), to the extent that it is not unusual to have several designers, consultants, advisors, contractors, subcontractors, suppliers, specialists, managers and all manner of stakeholders in a project. For this reason, the contractual mechanisms by which they are engaged, and their roles, responsibilities and risks are defined, have needed to evolve to keep pace.

Surprisingly, perhaps, it is only comparatively recently that the designer and builder were appointed separately. The well-known architects in history, the likes of Christopher Wren, Robert Adam, John Vanbrugh and Nicholas Hawksmoor, would probably have employed all the tradespeople involved directly, as part of their commission from the client. It is possible that some form of tendering would have been involved, but most likely they would have used people they were familiar with, or based on reputation, rather than price alone.

Contracting methods

Once architecture was recognised as a separate profession, distinct from the master builder, focusing on design and supervision, it became necessary to find a different mechanism to reflect the new contractual arrangement. The result has evolved into what is now called “traditional” contracting, where a consultant is appointed to carry out design, and a builder is employed separately to undertake the construction work.

In recent years, however, there has been a bit of shift back towards design and build, where the attractiveness for the client of a single point of responsibility outweighs the relative loss of control over the project that comes with it.

When deciding on a form of contract, however, there are several other factors which need to be considered. As well as responsibility for design and supervision, these include the:

  • scope of work, including duration, complexity and the risk allocation between the parties

  • need for certainty and predictability of cost

  • importance of time — particularly where the work is to be completed in sections or parts.

How to contract the price of the project

For the most part, the vast majority of construction contracts are described as fixed (or firm) price lump sum contracts. In reality, this doesn’t mean that the price is actually fixed, in the sense that the price doesn’t change, or that the lump sum cannot be subdivided into its constituents using a schedule or bill of quantities, but it does mean that the way it is calculated and can change is known at the time the contract is signed.

There are a number of variants on this theme: some contracts include provisions for dealing with price increases due to inflation or changes in tax, for example. This may be calculated using price adjustment formulae or a series of indices.

Other pricing mechanisms include guaranteed maximum price, or a target price, where there is an “incentive” procedure for sharing savings or allocating responsibility for extra costs.

Where the need to start on site is considered more important than the out-turn cost, eg where a building needs to be made safe after a fire or some other emergency, it may be agreed that the work can be remeasured as it is carried out and valued based on the cost of materials and labour — with the addition of a percentage for profit, and perhaps a fee for overheads. This is usually referred to as “cost reimbursable” or “cost plus”, or sometimes “time and materials”.

Different contract types

There are a quite a few different ways in which these contracts can be set up, some examples of are as follows.

Traditional

As described earlier, design and construction are separate. The building contract is between client and contractor, and the design contract is between the client and the designer (typically an architect or other consultant).

Design and build

The contract is between the client and builder, but the latter takes responsibility for design as well as construction. However, it is not unusual for the client to also appoint a separate consultant to assist with the process of preparing the client’s brief for the project, although this appointment may ultimately transfer to the contractor using a process of novation, as it is felt that they are best placed to understand the brief, and therefore the design process is better served.

There are a number of variants on this theme, including Design, Build, Finance and Operate (DBFO) and Build, Own, Operate and Transfer (BOOT), which involve the builder carrying out design and construction and maintaining the building for a period of years, in exchange for a regular payment. This is the principle behind the Government’s Private Finance Initiative (PFI) procedure.

Prime cost or cost plus

Where it is important to get an early start on site, it is sometimes expedient to reimburse the builder on the basis of the actual cost of labour and materials, with the addition of a fee, or a percentage addition to cover overheads, profit and other administrative costs. There may be a design carried out by a consultant but more often than not due to the nature of the work — typically emergency repairs or reinstatement following fire or structural collapse, where the actual extent cannot be fully assessed in advance. The element of competition is diminished somewhat — the only competitive element is the fee, but the advantages of an early start and known cost elements mean that this method retains popular in particular circumstances.

Term contracts

These are often used for reactive repairs and maintenance, where the tenders are sought based on a schedule of rates for commonly used work items — replacing a window, or a roof tile, for example, and the client issues a series of “orders” on an ad hoc basis when work of this nature is required. The actual work is valued on the basis of the items and rates in the schedule, and the builder is retained for a set period — the “term” referred to in the contract. There are a number of similarities between this arrangement and a Framework Agreement, where a number of builders are retained in the framework, and invited to bid for call-off packages of work as and when they arise. The important feature of both arrangements is that the type of work is known even if the extent of each order or package is not.

Construction management and management contracting

Two slightly more bespoke arrangements are “Construction Management” and “Management Contracting”. These are quite similar in approach — essentially, the project is subdivided into a number of smaller packages, either by trade or location and the construction manager or managing contractor is responsible for things like programming and project management. The main difference is the contractual mechanism: the construction manager is employed as a consultant and has no direct contractual link with the package contractors, whereas the management contractor subcontracts all the packages, without actually undertaking any of the work.

Next steps

With any of the methods above, a partnering or alliancing agreement can be overlaid. At its simplest level, this means that all parties sign up to an overarching agreement that commits them to act in a mutually co-operative way, although the wording may be different in each case. Some publishers have produced specialist partnering or alliancing forms, which incorporate one or more of the methods listed above.

Finally, a note on pricing methods. There are a number of ways in which the contract sum can be broken down and used primarily to value progress and variations. The most popular are bills of quantities or schedules of rates. Importantly, to be effective, these must be listed as a contract document, so some publishers amend their wording to accommodate different methods.

For detailed information and guidance, see the Croner-i Contracts for Construction topic.

Roland Finch BSc FRICS ACI Arb is a technical author for the National Building Specification (NBS) specialising in preliminaries. The views expressed here are those of the author and should not be taken as representing either NBS or RIBA Enterprises Ltd.

Last reviewed 14 November 2018

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