19 November 2018

Pricing-methods-in-construction-and-engineering-contracts-whats-in-the-price

This article was written by Chau Ee, Lee Xu Xianhong , Zhang Zhuoxian.

The Belt and Road Initiative

 

China’s Belt and Road Initiative spans more than 70 countries, with an increasing number of international investors, lenders, developers and contractors involved. Indeed, an infrastructure initiative of this scale inevitably generates different forms of construction and engineering contracts for the various trade packages (with each identifying the particular type of work to be carried out) – therefore no one-size fits all. Against this backdrop, it may be opportune to refresh ourselves on a number of common pricing methods used internationally to assist us in determining which form of contract pricing is most appropriate for any given construction and engineering contract.

Types of pricing methods

As a starting point, it is worthwhile pointing out that there may be situations where distinct trade packages in a construction process require different pricing methods.

(1) Re-measurable

The first pricing method is typically known as the re-measureable form, which by way of example, is adopted in the FIDIC Red Book Second Edition 2017 (as it was also the case in previous Red Book editions). 

Clause 12.1 [Works to be Measured] of this Red Book provides that “The Works shall be measured, and valued for payment, in accordance with this Clause.” 

In this pricing method, the employer accepts the risk of variations in the quantities originally estimated.

At the tender stage, prospective contractors would fill in a proposed unit price or rate for each item of work and the contract price is calculated by adding the priced items in the bill of quantities.

Payment of the contractor for the value of the works completed is in accordance with the contract. Therefore, the bill of quantities, which consists of a number of items and a certain quantity to each item, is a key contractual and pricing document in the circumstance where the re-measureable method is used.

This is particularly true in civil engineering works, where often the quantities are unpredictable given the high content of ground surface work.

(2) Cost-reimbursable

Another pricing method is commonly termed as the cost-reimbursable form. The employer accepts the entire risk of carrying out the work and the contractor is reimbursed for the actual cost of carrying it out plus a fee.

This pricing method does not however have an applicable FIDIC form. In light of its rather special nature, bespoke amendments will have to be made to the Engineer’s powers in the General Conditions of any given FIDIC form by way of the Particular Conditions.  Accordingly, the common consensus has been that FIDIC forms may not necessarily be appropriate for this pricing method.

Possible variants of this pricing method include cost plus percentage fee, cost plus fxed fee, cost plus fluctuating fee and target price contracts, which could include a Guaranteed Maximum Price (GMP)  slant.

The GMP is basically a monetary value which caps payments to the contractor. Arguably, there should be wording in the construction and engineering contract to prevent the contractor from asserting other types of claims or damages.

Proponents of a "pure" GMP contract will almost always insist on having these couple of key aspects addressed, being (a) the cost to the contractor for carrying out the work in terms of how it is calculated and what the work actually entails and (b) what actually constitutes the price. Absent agreement on these two aspects, it can be said that there is no "pure" GMP contract in existence.

The cost-reimbursable form is used preferably where the nature of the works cannot be properly definedat the outset, and where an immediate start on site is required.

(3) Lump sum

The third commonly used form is the lump sum method as adopted in the FIDIC Yellow Book and the FIDIC Silver Book in terms of pricing albeit with their respective nuances.

Clause 14.1 [The Contract Price] of the FIDIC Silver Book Second Edition 2017 provides that “Unless otherwise stated in the Particular Conditions: (a) payment for the Works shall be made on the basis of the lump sum Contract Price stated in the Contract Agreement…” 

Clause 14.1 [The Contract Price] of the FIDIC Yellow Book Second Edition 2017 provides that “Unless otherwise stated in the Particular Conditions: (a) the Contract Price shall be the lump sum Accepted Contract Amount…” 

For a contract adopting the lump sum method, a single “lump sum” price for all the works is agreed before the works begin. Under this circumstance, the employer accepts the least amount of risk with respect to quantities and the contractor is obliged to carry out all the work included in the contract documents for a fixed-fee tendered specified sum. Therefore, it is generally regarded as useful where the quantities of the project are expected to remain unchanged.

Obviously, where there are adjustments, additions (or deductions) to be made in accordance with the contract, the price may have to be re-adjusted accordingly. For instance, when there could be events that would entitle a contractor to receive extra payment, particularly where inaccurate drawings and contract documents do not describe the work – in this case, a bill of quantities may be used for that purpose

Assuming that design is in a fairly advanced stage, it is likely that the lump sum form would be adopted.

Lump Sum Contract Price versus GMP

The ultimate aim of both lump sum contracts and GMP contracts is for the consultant to sit down with the employer to discuss a maximum cost for the project. Yet one would invariably find that the difference is almost purely administrative.

In a GMP contract, payment is usually made as the work is completed, based on actual invoices for sub-contractors and materials. On the other hand, while a negotiated lump sum contract means that the price remains fixed, but due to cash flow management or to minimise the administrative aspects, the contractor bills on a pre-set payment schedule.

Other considerations

Other key issues arise in deciding the appropriate pricing methods to suit the circumstances. For instance, taxation and currency-related matters can complicate payment terms.

Key contacts

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