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University of Rome Tor Vergata

May 2014

© European Bank for Reconstruction and Development 2010 | www.ebrd.com

European Bank for Reconstruction and Development

Module 12 - Contract Management

Evgeny Smirnov

Senior Procurement Specialist

Procurement Department

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Objectives

During this module we will discuss:

Relationship between procurement process and contract management

Main type of contracts

Roles and Responsibilities of the parties under different contracts

Proactive contract management

Establishing systems and practices to avoid disputes and to resolve disputes when they arise

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University of Rome Tor Vergata

May 2014

© European Bank for Reconstruction and Development 2010 | www.ebrd.com

Contracts

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What is contract?

A voluntary, deliberate, and legally binding agreement between two or more competent parties.

Contracts are usually written but may be spoken or implied.

A contractual relationship is evidenced by an offer,

acceptance of the offer, and

a valid (legal and valuable) consideration - the promise given by both parties as the

"price" of entering into the agreement.

Each party to a contract acquires rights and duties relative to the rights and duties of the other parties.

While all parties may expect a fair benefit from the contract (otherwise courts may consider them as inequitable) it does not mean that each party will benefit to an equal extent.

Existence of contractual-relationship does not necessarily mean the contract is enforceable, or that it is not void or voidable.

Contracts are normally enforceable whether or not in a written form, although a written contract protects all parties to it. Some contracts must be in writing to be legally binding and enforceable. Other contracts are assumed in, and enforced by, law whether or not the involved parties desired to enter into a contract.

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Key Factors

Quality

Time

Cost/Price

For the success of the contract the parties shall maintain the balance between COST, QUALITY and TIME.

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Ability to influence

Time

Ability to influence

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Relationships between parties

Positive

Neutral

Negative

Positive

Maximum

benefits for

both parties

Risks of

negative

influence by

external factors

Lack of

motivation,

losses

Neutral

Risks of low

quality

Risk of

disputes, high

risk of negative

influence by

external factors

Delays,

loss of profit,

disputes

Negative

Low quality,

delays, cost

overruns

High risks of

cost and time

overruns, low

quality

Substantial loss

of time and

resources by

both parties

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Contract types

• Service contracts • Consultancy service • Goods supply • Works contracts

Small works

Construction works

Design and Build

Supply and Installation of Plant and Equipment

Engineering, procurement and construction

Managing contract

•Complex contracts Output and performance based contracts

Target price

DBFO

Partnership

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Selection of an appropriate contract type

• Nature, complexity and magnitude of the objectives

• Environment

• Sector and country business practices

• Resource availability

• Risk allocation between the parties

MIN (Risk) = MAX (Success)

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Factors of influence

EXTERNAL FACTORS

Legal Framework

Industry practices

Development

Market conditions

Ethics (corruption)

CONTRACT

INTERNAL FACTORS

Objectives

Requirements

Parameters

In-house expertise/resources

capability

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Understanding the environment

Contract environment - political

- social

- economic

- legal

- industrial

- technical

- environmental

Limitations

Rules of the game

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Risks as seen by suppliers/contractors

Typical risks:

Political risks

Ownership of land and/or plant/Access rights

Regulatory requirements/bureaucracy

Climate/environment

Quality/reliability

Country/local experience

Presence/lack of local relationship

Contract conditions/local laws

ForEx risk

Local reporting/accounting

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Relationship between tendering process

and contract management

Chart from “Contract Management Guide" State Government of Victoria

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Tender

documents

Selection criteria Specifications

Project definition

External factors

Contractor selection

procedures

Contracting arrangements

Contract Tender procedures

Relationship between tendering process

and contract management

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Contract cycle

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Contract cycle

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What is Contract Management?

Purpose - maximizing financial and operational performance and minimizing risks

Process - systematic and efficient management

Phases

contract creation;

execution; and

analysis

Key activities establishing (negotiating) the TERMS and CONDITIONS of contracts;

PLANNING activities;

controlling IMPLEMENTATION;

REPORTING progress;

making PAYMENTS;

managing VARIATIONS that may arise during the implementation phase;

documenting and handling CLAIMS;

preventing and resolving DISPUTES.

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Contract management functions

Analyse contractual obligations

Assemble a project team

Establish communication

Monitor performance

Document performance

Correct performance variances

Manage contract changes

Prevent and manage disputes

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13-14 June 2013

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Goods Supply Contracts

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Goods supply contracts

UN Convention on Contracts for the international sale of goods

Vienna, 1980

General provisions

Obligations of the seller

Delivery of the goods and documents

Conformity of the goods and third party claims

Remedies for breach of contract

Obligations of the buyer

Payment of the price

Taking over

Remedies for breach of contract

Passing of risks

Anticipatory breach and instalment contracts

Damages

Exemptions

Effect of avoidance

Preservation of the goods

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Logistics

Assessment of the circumstances

Risk identification

Development of risk mitigation and action plan

Packing Transportation Storage Customs clearance Documents

04/05/2014

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Incoterms

04/05/2014

INCOTERMS – International Commercial Terms

Internationally recognized standard, which is used in international AND

domestic contracts for the SALE OF GOODS.

First published in 1936

Launched in mid-September 2010, Incoterms 2010 came into effect on 1

January 2011.

Incoterms are recognized by UNCITRAL as the global standard for the

interpretation of the most common terms in foreign trade.

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Incoterms

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Payment terms

Currency

Time of payment

Method of payment

Documents

Forms

Barter

Cash

Cheque

Bank draft

Wire transfer

Payment on collection

Escrow account

Letter of Credit

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Payment terms

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Inspections

Allow to ensure that the Goods meet the technical requirements

An instrument to identify problems at early stages

Inspections can be undertaken at different stages and in different forms

Tests/Certification

Own resources/Outsource

04/05/2014

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Operation and maintenance

• Training

• Operation and maintenance manuals and other documents

• Call centres

• Spare parts stock and supply

• Warranty support

• Post warranty support

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Disputes

Partnership – Mutual Benefits

Problems – Failure Who is to blame? Insurances Securities Liquidated damages Arbitration Warranties Termination

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Risks

Factors that pose significant risk:

• imprecise/uncertain scope, requirements, specifications

• technical or logistical complexity

• large scale and/or short duration

• delivery terms are too optimistic

• weak contract administration

• reduction/loss of attention/interest by the Supplier

• inappropriate form of contract

• imprecise/inappropriate responsibilities, liabilities, damages

• conflicts of interest, collusion, corrupt practices

• unwillingness, inability to enforce contract conditions

• deliveries to other purchasers

• sub-suppliers’ failure to perform on time

• force majeure/unforeseen factors

• imperfection of legal system

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Works Contracts

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Investments in Infrastructure

Infrastructure is fundamental to both

economic development and plays a

crucial role in determining the quality

of life of individuals and societies.

An infrastructure deficit that some estimate

would require an annual investment of over

US$ 2 trillion each year over the next 20 years.

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Construction

Building is an inherently complex process that

involves directing the efforts of many people to create

a given result

It is a process that involves the evolution of an idea to a

graphical and written representation, which then must be

ultimately transformed into to a physical reality

At various points along the way, theory collides with

reality, resulting in conflict

In the long term, how fairly this process is done may

affect the number of willing participants in the process

Gene Ming Lee, A Case for Fairness in Public Works Contracting

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Construction process

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Why is it important?

Understanding Public Sector Procurement Process, Industry Capability Network, New Zealand

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Direct Account

Owner buys all materials and hires all staff and labor required for the works

Owner manages and supervises all works

Many public agencies (e.g. utilities) have traditionally worked this way

Used for activities such as maintenance, rehabilitation, small works, etc. Owner

project

design materials manage labour

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Multiple Contract Packages

Referred to as package deals, island packages

Project broken up into a number of discreet contract packages

Owner responsible for design, project management, interfaces and overall performance

Owner can also contract out design and/or management

Examples: construction management, management contract, project management

Owner

A/E

S S S S S

contractor contractor contractor

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Conventional

Two separate sequential contracts

design/supervision (architect/engineer)

construction (general/prime contractor)

A/E

SC SC SC

S S S S

Owner

General contractor

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Single contract

•Single responsibility

•Design and build

•EPC

•Turnkey

•Concession/BOT

Single responsibility

contractor

Owner

Design Engineering Construction

Procurement

Administration/Finance

SC

SC

SC

S

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Selection of contract terms and conditions

• Identification of risks and risk mitigation plan

• Contract structure Number of contracts

Contract types

• Are influenced by:

Project requirements

Employer’s own resources

Market situation

External factors

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Selection of contract terms and conditions

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New Engineering Contracts (NEC)

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FIDIC Contracts

The International Federation of Consulting Engineers

(FIDIC) is an international standards organisation for the

construction industry

Fédération Internationale Des Ingénieurs-Conseils

Best known for the FIDIC family of contract templates.

It was established in 1913

The FIDIC founding member countries were Belgium,

France and Switzerland

89 member countries as of 2012 (with a target of 100

members by end 2013)

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Roles and Responsibilities

FIDIC Contract Types

Construction (CONS/Red Book) / Plant and Design-Build (P&DB/Yellow

Book)

– Use where: the Employer wishes to be kept fully informed of the Contract’s

progress and appoints an Engineer to administer the Contract on his

behalf.

EPC/Turnkey (EPCT/Silver Book)

– Use where: the Employer wants greater certainty of final cost and project

duration and wishes the Contractor to take total responsibility for the

design and construction of the facility.

Other forms of Contract

– Short Form (Green Book)

– Design, Build and Operate (Gold Book)

– Multilateral Development Bank (MDB) Harmonised Edition of the Red Book

(Pink Book)

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Roles and Responsibilities

Summary of Roles by Contract Type:

FIDIC Contract Type Role

Employer Contractor Engineer Employer’s

Representative

Construction

(Red Book) X X X

MDB Harmonised Construction

(Pink Book) X X X

Plant and Design-Build

(Yellow Book) X X X

EPC/Turnkey

(Silver Book)

X X X

Design Build and Operate

(Gold Book) X X X

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Works Contracts

Contract

Employer

Contractor Engineer

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Roles and Responsibilities: the Employer

Owner of the site

The beneficiary of the Works

Responsible for defining the intended

purpose of the Works and for setting out

the Employer’s Requirements

Enters into a contract agreement with the Contractor

Appoints a Representative/Engineer to oversee the execution of the

Works

Has the right to amend the contract

Pay for the Works done

Jointly with the Contractor, appoints a Dispute Adjudication Board (DAB)

Takes over the Works, when completed

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Roles and Responsibilities: the Contractor

Design, execute and complete the Works and remedy any defects

Undertake all other responsibilities

Manage staff and labour in accordance

Carry out the manufacture of Plant, the production and manufacture of

Materials, and all other execution of the Works according to good practice

and with properly equipped facilities

Abide by the laws and bylaws, as well as the instructions of the Engineer

Make claims in accordance with the Contract

Complete all the Works within the Time for Completion

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FIDIC: The importance of the Engineer

For this reason care must be taken when reviewing the TOR for the engineers.

They must be suitably experienced in FIDIC and must have an adequate funding

Role of Engineer crucial

The Engineer acts for the Employer in supervising

the activities by the Contractor

The Engineer issues all contractual notices to the

Contractor

The Engineer determines any variations

The Engineer issues the Interim Payment

Certificates

The Engineer under FIDIC is NOT independent –

he acts for and on behalf of the Employer

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Roles and Responsibilities: the Engineer

When using Red or Yellow Book the Engineer Key Responsibilities are:

Exercises authority on behalf of the Employer as specified in the Contract

Makes fair determinations on matters related to Contract execution

Review the Contractor’s quality assurance system

Review the Contractor’s work programme

Oversee Tests on Completion

Manage Variations

Issue Payment Certificates

Manage Claims

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Roles and Responsibilities: Administration of the Contract by the Employer (EPC/T)

Employer’s Administration:

May delegate authority to an Employer’s Representative

Retains authority for the administration of the project and executes most

of the functions assigned to the Engineer in CONS and P&DB.

Expects much less of a hands-on administrative role than in CONS or

P&DB.

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FIDIC Red Book

General provisions

The Employer

The Engineer

The Contractor

Nominated Subcontractors

Staff and Labour

Plant, Materials and Workmanship

Commencement, Delays and Suspension

Test on Completion

Employer’s Taking Over

Defects Liability

Measurement and Evaluation

Variations and Adjustments

Contract Price and Payment

Termination by Employer

Suspension and Termination by Contractor

Risk and Responsibility

Insurance

Force Majeure

Claims, Disputes and Arbitration

FIDIC CONDITIONS OF CONTRACT FOR CONSTRUCTION FOR BUILDING AND ENGINEERING WORKS DESIGNED BY THE EMPLOYER

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FIDIC Order of Precedence

Contract agreement

Letter of acceptance

Letter of tender

Particular conditions

General conditions

Specifications

Drawings

Schedules

Other documents

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Organisation Structure

Contract organisation structure and human resources

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Contract management unit

•Composition •Education, knowledge and experience in:

– Management – Engineering and other technical skills

– Operation and maintenance experience

– Financial management and accounting

– Environment protection

– Health and safety

– Legal issues

– Communication skills

– Individual qualities

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Organisation and Mobilisation

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Planning

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Planning

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Establishing a Project Plan

Questions to ask:

Is the project still on programme?

Does the Employer’s Requirements still reflect the Employer’s needs?

Will the Contractor still be able to supply works, goods and materials on time?

Who will supervise the works?

Have the administrative procedures been documented and agreed to?

How will variations be priced and authorised?

What work has to be completed before each interim payment?

Has a Dispute Adjudication Board been appointed (if a standing DAB is

selected)?

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Establishing a Project Plan

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Establishing a Project Plan

Guidelines for drafting a Project Plan

Keep the plan simple and clear

Ensure the Employer and Contractor are equally considered;

Include a risk matrix with clear contingency plans

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Common pitfalls in Planning

Not committing sufficient resources upfront for the preparation and support of

a project plan;

Failing to establish an accurate baseline for the Project Programme at the

commencement of the works;

Failure to establish clear levels of authority for authorisations of claims and

variations;

Assuming that the conditions of contract are clear on particulars of payments

and reporting and fully understood by both Parties;

Other pitfalls – relating to failure to complete items on the project plan

template/checklist

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Site Organisation

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Construction Methods

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Quality Control

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Quality Control

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Time Control

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Cost Control

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All

Information required

Minimal

Lump sum

Recalculation

Cost cover

Min Employer’s Risks Max

Max Contractor’s Risks Min

Contract pricing

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Contract pricing

Unit price based

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Contract pricing

04/05/2014

Unit price based

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Lump sum based

Contract pricing

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Cost Control

•Analysing

•Planning

•Budgeting

•Monitoring and controlling

•Reporting

Costs:

Itemised plan

Cash flow

Responsibilities

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Cost Control

CUMULATIVE CASH FLOW

Cash flow

amount

Time

Forecasted cash flow

Actual cash flow

74 © European Bank for Reconstruction and Development 2010 | www.ebrd.com

Cost control

Issues to consider:

• Foreign exchange fluctuations

• Index dynamic

• Labour/material market situation

• Logistics

• Actual cost

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Contract pricing

Fixed or Adjustable price?

Time

Costs

Tender price

Actual cost

Price

escalation

BD TO CS Contract implementation

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Financial control

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Time control

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Time control

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Progress control

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Triple Constraint for Works Contracts

Contract Management

“Triple Constraint”

Time

(Time for Completion)

can be extended by

CLAIMS/VARIATIONS

Cost

(Contract Price)

can be adjusted by CLAIMS/VARIATIONS

Scope

(Scope of Works/BOQ)

can be changed through VARIATIONS

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Managing the Triple Constraint

VARIATIONS

Variations to change scope may originate with the Engineer or the Employer at any time

Under the Value Engineering clause the Contractor may propose variations to benefit the

Employer

CLAIMS (are claims for time or cost or both):

Made with respect to the Contractor’s entitlements under the Contract (shall not to be

confused with disputes).

Originate when the Contractor notifies the Engineer or Employer.

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Records of Contractor

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Records of Contractor

Monthly reports

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Control

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FIDIC Contract Issues

Provisional sums

Day works

Price adjustment

Work program

Insurance policies and certificates

Deviations and/or alternatives

Subcontractors

Adjudication/arbitration

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Risks in construction

Injury and damage risks

• Employer’s risk

• Contractor’s risks

• Contractor’s obligation to insure

Financial risk

• Employer or Contractor fails to meet contractual obligations

• Inflation (if there is no price adjustment)

• Technical risks

• Cost increase

• Design errors

• Unforeseen conditions (especially underground)

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Factors that pose significant risk include:

imprecise/uncertain scope, requirements, specifications;

large number of interfaces;

technical or logistical complexity;

large scale and/or long duration;

weak project management and/or contract administration;

inappropriate form of contracts;

imprecise/inappropriate responsibilities, liabilities, damages;

conflicts of interest, collusion, corrupt practices;

unwillingness, inability to enforce contract conditions;

force majeure/unforeseen factors;

Bureaucracy;

imperfection of legal system

BEWARE OF CONTRACTUAL RISKS!

Risks in construction

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Risks in construction

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Insurances

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Issues to consider

Contract implementation phase

Standards

GOST (State Standards)

SNiP (Construction Norms and Rules)

ENiR (Unified Norms and Rates)

SanPiN (Sanitary Norms)

Conformity

Certification by RosTechRegulation

Ordinary goods/equipment

Certification by RosTechNadzor

High danger goods (high pressure/temperature/lifting equipment etc.)

Certification by RosPoterbNadzor

Chemicals, building materials, water supply equipment etc.

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Issues to consider

Contract implementation phase

Licensing/SRO membership

Main activities

Specialised works

Accounting

Taxation

Customs clearance

Procedures

Documents

Time

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Beware of corruption

• Identification

• Prevention

• Monitoring and audit

• Liquidation

C = f (M, DM, R)

where:

C Corruption M Monopoly DM Decision Making

О Responsibility

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Delays

Delays can occur frequently and both parties tend to blame each other.

Common delays:

• Late possession of site

• Employer has not obtained required permits

• Contractor, employer or local authorities has not provided/approved design

• Local construction law or practice differs from assumptions

• Extreme weather conditions

• Rise in cost of materials/labour

• Reactive/passive position FIDIC engineer

• Delay in payments

• Failure of sub-contractors

• Failure to issue acceptance certificate

• Technical faults

• Disputes

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Common claims

Uncertain requirements

Employer’s/Authorities’ interference

Delayed access to site

Climatic and environmental differences

Personnel and labour risks

Payment delays

Subsoil conditions

Availability of materials

Variations

Acceleration of works/extension of time

Cost increase

Quality of works

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Disputes

The Engineer determines claims by both parties

If no agreement, amicable settlement available

If no settlement, refer to DAB

If parties do not agree on DAB decision then refer to arbitration

Generally arbitration under local courts and national law.

Can be under UNCITRAL or ICC rules or other rules

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Resolve performance issues

Can issue contract notice or ‘notice to correct’ under FIDIC

Amend the contract to mitigate the performance issue

Impose liquidated damages

Threaten suspension or termination of contract

Go to adjudication or arbitration

Appoint Dispute Arbitration Board

File with local/international courts

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Avoiding and Resolving Disputes

General Principles

Ensure all of the Parties clearly understand their specific roles and

responsibilities under the chosen form of Contract;

Clearly lay out the implications of the Contract pricing structure for pricing

and managing Claims made by the Contractor;

Clearly specify a framework for pricing and administering Variations;

Consider carefully the administrative structure of the Engineer and the

Engineer’s staff;

Assess the benefits of appointing a standing DAB;

Take care to ensure the appointment of an Engineer with the request

technical expertise and experience in Contract Administration and will

execute the role with care and fairness

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The Role of the Engineer

Must exercise professionalism and independent thinking in applying the

Contract to facts and circumstances presented by the Parties;

Makes determinations (in accordance with over 35 sub-clauses in CONS

and P&DB);

Be proactive in the identification and resolution of potential areas of conflict

(“prevention better than cure”);

Consider the benefits of keeping the Site at arm’s length and conduct

administration through the Engineer (in order to increase objectivity)

Avoiding and Resolving Disputes

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Stages of Dispute Elevation

Step 1 - “Court of the first instance”

The “court of the first instance” is the Engineer and the Engineer’s staff. The

Resident Engineer should be the first point of contact if a dispute arises;

The Resident Engineer (depending on her level of authority to resolve claims

and other sources of disputes) elevates the dispute to the Engineer;

If the Parties do not agree with the Engineer’s determination, the dispute is

presented to Dispute Arbitration Board;

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Stages of Dispute Elevation

Step 2 – Dispute Arbitration Board

A standing DAB has the advantage of on-going access to the Site and real-

time dispute resolution;

A standing DAB can maintain open lines of communication with the Parties

and the Engineer can address potential disputes as they arise rather than

waiting until the Parties are entrenched in their positions;

Use of a DAB can avoid going to international arbitration;

Failing resolution by the DAB, a dispute can proceed to local

court/international arbitration, a potentially costly and time-consuming

process.

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Pro et Contra of using FIDIC contracts

“There is nothing either good or bad, but thinking makes it so…” Hamlet, William Shakespeare

Questionnaire, April 2012

20 questions about FIDIC contracts Section A; General Information

Section B; Overall experience with FIDIC contracts

Section C; Specific issues (anti-corruption, social and

environmental provisions, Engineer’s role, DAB)

Responses

• 12 countries in Eastern Europe, Turkey and FSU countries

• Power, Transport, Municipal and Nuclear Safety sectors

• 38 respondents

• Contracts range: EUR 3 million to EUR 990 million

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Pro et Contra of using FIDIC contracts

“What's in a name? That which we call a rose…” Romeo and Juliet, William Shakespeare

View of EBRD

• Well balanced contracts

• Easily adoptable to specific country conditions

• Specific MDB provisions included

• Suitable for a wide range of projects

• Well known on the market

• Aimed at timely completion within the original cost

• Presence of a professional engineering support

• Efficient dispute resolution mechanism

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Pro et Contra of using FIDIC contracts

“Beauty is bought by judgement of the eye, Not utter'd by base sale of chapmen's tongues…”

Love's Labours Lost, William Shakespeare

View of Respondents

• Users are generally satisfied

• Well balanced risks of the parties

• Fair and complete

• Well known throughout the industry

• Simple, but covering main contractual issues well, being based on vast experience

• Standardisation and availability of the documents for different type of projects

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Pro et Contra of using FIDIC contracts

“Oft expectation fails and most oft there

Where most it promises, and oft it hits

Where hope is coldest and despair most fits”

All’s Well That Ends Well, William Shakespeare

Other views

• Requires localisation, as some terms contradicts to a local legislation

• Not well known by local contractors

• Lack of experience and incomplete understanding by some employers

• Open for claims

• Lack of (limited) control in respect of delays in the course of the works

• Cost and time overruns are quite common

• Requires more detailed procedures in respect of delays and suspension of the

works

• Engineers act in favour of their employers and often carry their duties passively

• Dab is used rarely and is not efficient

• Sometimes clients use incorrect forms of FIDIC contract on their projects

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