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Pricing and payment under construction and supply agreements
David Nancarrow
DLA Piper Australia
17 March 2015
Introduction
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"A penny saved is a penny earned"
- Benjamin Franklin
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Pricing vs Payment
Pricing – how the total amount payable is determined
Payment – how the amount payable is paid
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Structures for pricing
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Number of possible ways to structure pricing:
Lump sum or fixed price
Guaranteed Maximum Price (GMP)
Provisional sum (or provisional sum items)
Cost reimbursable (cost plus)
Schedule of rates
Most appropriate structure will depend on the particular circumstances and nature of the work
Contracts can include a combination of pricing methods
Pricing structure is not the same as the contract structure
Lump sum = pricing structure
EPC, Turnkey, etc. = contract structure
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Lump sum / fixed price
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Contractor provides fixed sum for the completion of the whole of the works
Rarely is it absolute – usually subject to adjustment
Suitable when extent of work is known and workcan be can be accurately priced
Not appropriate if the scope of work is not known or well defined at the commencement of the contract
Can be easy to administer
Lump sum/fixed price method impacts on relationship between principal and contractor
Lump sum / fixed price - variations
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Contract will invariably allow the fixed price to be increased in certain circumstances:
usually when the scope of work has been varied by the principal; or
for cost increases which the contractor could neither reasonably foresee or control, such as latent conditions, industrial action and change in law.
Should be clear processes set out in the contract for claiming and determining a variation
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Provisional sums
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Provisional sums are used when the principal has not yet decided whether to include certain items as part of the scope or the items are to be included but the quantity or type is not yet known
Process for converting the provisional sum into a confirmed part of the scope must be clearly set out in the contract
Key issues to consider and document include:
clear description of scope
reasonable estimate (the provisional sum)
process for pricing
Contractor entitlement to profit
Cost reimbursable
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Cost-reimbursable or cost-plus structure compensates the contractor for the costs of the work completed with added amounts for profits and overheads
Principal carries the risk of project costs increasing
Requires detailed records and verification of costs to be reimbursed (often referred to as "open-book")
Can be an appropriate method when quantities are unknown or if the works involve new or complex methods or technology
Allows for greater potential for transparency in relation to costs and profit
$0.00
$100.00
$200.00
$300.00
$400.00
$500.00
$600.00
$700.00
Time
Cost
Costs + Profit
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Schedule of rates
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Amount to be paid is based on an agreed price per unit of construction
Unit of construction may be based on:
time (e.g. hourly rate)
quantity of material (e.g. tonnes of soil removed)
quantity of construction completed (e.g. kilometres of pipe laid)
The contract specifies units used and their value in a schedule usually called "schedule of rates"
Risk allocation:
principal bears risk of quantity necessary for job
contractor bears risk for fluctuation in unit prices
Currency fluctuations
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Currency of pricing and payment is critical for cross border projects where:
key items sourced for construction are priced in a currency different to the payment price
where parties are headquartered in different jurisdictions and principally operate in different currencies
Risk of currency fluctuations can be hedged against
Fluctuations in exchange rates can also work in favour of a risk-bearing party
Allocation of currency fluctuation risk should be expressly dealt with in the contract
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Rise and fall
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The direct costs of performing the construction contract are likely to rise and fall during the course of construction
Not all risk cannot be controlled by the principal or the contractor
Contracts may provide mechanisms for adjusting contract price to reflect changes in costs
Cost adjustment may be applied to labour or materials
If there is no adjustment mechanism for the rise and fall of long-term costs, contractors may when tendering:
overestimate the costs (inflating the project costs) or
underestimate the costs (risking the financial viability of the project)
Options for payment
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Options for payment:
advance payments
progress payments
milestones
value of work completed
on-site
off-site
fixed
Cash flow is critical
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Structures for payment – progress
payments
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Value of work completed progress payments are the most common structure for payment in major projects
Contractor remunerated for work completed during a given period
Progress payment process:
contractor submits a description of work completed during the previous time period, along with details of the value of the work
completed work is certified and valued
contractor is then paid the certified value of that work minus any retention, advance payment deduction or any other sum owing from the contractor to the principal
Progress payment as interim payment
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Progress payments are not final determinations of the value of the works
Progress payments are an interim assessment of the value of the works
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Materials not yet incorporated
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Contract must clearly state when the contractor is entitled to be paid for materials which is ordered and partially complete but not yet incorporated into the works
Must state:
the materials and equipment that will be paid for;
the amounts payable;
timing and requirements for payment.
Other issues to be dealt with are:
when does title pass/who bears the risk/who must insure the materials; and
the impact of the Personal Property Securities Act 2009 (Cth) (PPSA)
Subcontractors and employees
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Timing:
responsibility of contractor to ensure that the timing of payment provisions under a main contract align with the timing of payments to subcontractors under any subcontracts
Information requested from the subcontractor for payment should align with the information required under the main contract
"Pay if paid" and "pay when paid" arrangements are prohibited by law throughout Australia
A contractor cannot make the payment of its subcontractor contingent on the contractor being paid by another person (such as the principal)
a provision of a construction contract that purports to do this has no effect
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Security of payment
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Each state has enacted legislation
In WA it is Construction Contracts Act 2004 (WA)
Key provisions include:
act applies to defined work carried out in WA
prohibition on pay if/when paid clauses
maximum 50 days from claim to payment
implied provisions if contract is silent on payment progress
dispute adjudication process
Set off
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Right of set off common in construction contracts
Set off rights allow the principal to set off any amounts owing from the contractor to the principal from any amounts the principal is otherwise obliged to pay the contractor under the contract
For example:
if contractor owes principal liquidated damages for late completion; and
principal also owes progress payments to the contractor; then
principal can deduct the amount of the liquidated damages owed from the progress payments the principal owes to the contractor.
Liquidated Damages
Progress Payments
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Interest
Suspension
Termination
Security of payment adjudication
Dispute resolution
Remedies for non-payment
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Conclusion
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Consider and agree methods that are best for project
Ensure contract drafting is detailed and clear
Train contract administrators
Comply with the contract
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Questions
Key Contacts
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David Nancarrow
Partner
T: +61 8 6467 6028