Project contracting system

.. rather, how the contracting system influences the very project realization, rights and duties of the client and contractor.

All following considerations and suggestions are elaborated following existing experience with various investors and with various demands on their projects realizations. In this part, I would like to mention advantages and disadvantages of separate contracting systems and I’ll also try to recommend investors the best system for their projects realization.

CONTRACTING SYSTEMS VARIANTS

1. – Variant A .. General contractor – “turn-key” contracting with concluded Contract of Work
2. – Variant B .. General contracting with Contract of Work based on “cost + fee”
3. – Variant C .. Engineering services with Consignment Agreement
4. – Variant D .. Engineering services with Contract of Mandate

Summary and partition of engineering services for separate variants.

 

Inv = Investor, Con = contractor of engineering works, according to separate variants

 

Variant A – General contractor – “turn-key” contracting with concluded Contract of Work

The investor signs an agreement for whole project realization provision with General contractor that is an Engineering company – by means of “turn-key” realization.

We call this model a “turn-key” model. This model is favoured by financially strong investors for whom the model provides adequate convenience and confidence in their project realization at the cost of certain capital expenditures increase. The general contractor’s responsibility is the complete construction control, including the financial flow control, separate contractor’s selection and concluding of contractual relations with them. The Investor has only one contractual relation – with the general contractor and he isn’t in a position of dealing separately with the subcontractors.

It is important to realize that the Investor isn’t in a position to gain surveillance over the actual investment price and therefore, this model enables the Engineering Company to achieve above standard profits. Indeed, this risk is partly eliminated by implementation of tenders for General contractor but in any case, the total price will be higher than in a system following variant B.

On the other hand it is important to realize that this model offers the best guarantees for the Investor. The General contractor undertakes complete guarantees toward the Investor in a range agreed in the Contract of Work. In case of the necessity of some extra expenses that are higher than the ones stated in the agreements with separate contractors, the General contractor is liable for these payments and the Investor is guaranteed against them. So-called Reserve fund is created by the General contractor for this purpose – in an amount of about 10-15% of total investment volume of the Engineering Company.

At this contracting system, the Investor may examine the investment amount thoroughly, before the Contract of Work is signed. In case of a properly concluded agreement and clear Investor’s requirements confirmed by his signature, this model sets complete and, above all, final price of the project at the very beginning.

Variant B – General contracting with Contract of Work based on “cost + fee”

The Investor signs the contract of the complete project realization, securing the “turn-key” with the General contractor which is an Engineering company. The difference with the previous system is in the reimbursement method and in the work guarantee provision.

General contractor obligations:

• To elaborate and to terminate the complete project/construction in agreed term
• To realize the complete project/construction for arranged and approved limit price
• To provide guarantees for the overall quality of the realized project/construction including every controlled supply (by the General contractor) and to provide guarantees for the technology operation if the General contractor is the technology bearer

This model – compared to the Consignment agreement – delegates more decisions on the General contractor about how to use the sources for project securing. In the scope of works of the General contractor the documentation elaboration is also in agreed amounts. The Investor has only one contractual relationship – with the General contractor and he isn’t in a position of dealing separately with the subcontractors.

In this instance, the price is set according to the figure „cost + fee“, that means:

TC = DC + Fee + R

where

1. TC = total project cost, the price between the Investor and the General contractor
2. DC = direct costs of separate deliveries, equipment, services
3. Fee = fixed approved fee for engineering for the General contractor
4. R = approved reserve for extra work, changes, risks, etc. connected with the project realization, usually in the range of about 5%

At this cost, the General contractor is not obliged to take serious measures for risks elimination and that reduces the total construction costs. The Investor always controls the actual construction costs in this system of financing. The General contractor can’t make above standard profits, therefore it is common to conclude an incentive contract for contractual bonus achievable in case of the construction’s compliance or decrease of the set construction costs.

The General contractor is responsible for coordinating all the works, general engineering solutions and he also guarantees for the whole Work. The Investor has to comprehend that in this model, the General contractor guarantees for all the works and deliveries up to the guarantees from the separate contractors. In case of a necessity to pay for some extra costs that are higher than the sums agreed on with the individual contractors, the means from the set reserve are used. In case that it is necessary to pay for the costs that are higher than the responsibility of separate contractors is, means from set reserve are used

Variant C – Engineering services with Consignment Agreement

Commission agent – Engineering company organizes and controls the project in its own name for account of the Investor – Principal.

All contractors (of equipment, works and services) are chosen by the Investor in terms of the Engineering company recommendation, the separate contracts are then concluded between the Engineering company and the contractor, but the payments to contractors are realized directly from the Investor’s account. The guarantees for supplies (claims) are provided by the contractors directly to the Investor who usually entrusts the Engineering Company and this company ensures any removal of faults from the separate contractors. In this realization system the Engineering company bears more guarantees for terms and total investment costs than in Variant D.

Variant D – Engineering services with Contract of Mandate

This model is very similar to the previous model, but here the Mandatary – Engineering Company organizes and controls the project in the name of Mandant´s – Investor’s and on its account.

This model requires considerable experience of the Engineering company with control and coordination of the project, it is difficult in terms of administration, project logistics and individual steps discussion with the Investor. In this model it is also appropriate for the Investor to have at least an elementary knowledge of capital projects realizations and that he is conscious of all risks that it undertakes.

Usually, there are two contracts concluded between the Investor and the Engineering company – the Contract of Work for designing and the Contract of Mandate for engineering.

This model is suitable for an Investor who wants to realize a project with maximum possible control and minimal costs. The Investor participates actively in the operation and he can influence it directly while the project is in construction.

All contractors of equipment and works are chosen by the Investor in terms of references from the Engineering company, individual contracts are concluded between the Investor and the contractor. Project organization and work realization is though fully controlled by the Engineering company, but the Investor keeps general responsibility for the costs and project realization.

It isn’t possible to apply a general guarantee for the entire work, each contractor is a bearer only of guarantees for its own supplies. The contractor bears all guarantees directly towards the Investor, it means that the Investor objects his complaints at the contractor’s.

GENERAL EVALUATION AND RECOMMENDATION FOR INVESTORS

I’m aware of the fact that it isn’t easy to set some explicit rules about what type of system is the best to use for a given situation, it is necessary to discuss in detail each Investor’s decision separately. Yet, I’ve tried to mention a few remarks about this subject and to specify some borders for the decision making:

• The first chart shows that Variant A needs the highest financial investment but it is also the most convenient variant for the Investor, on the other hand Variant D is the cheapest but the most difficult for the Investor
• The more you direct from Variant A to Variant D, the more work you will have and, probably, the lower your investment will be
• The word “probably” is important here because the Variant D may become the most expensive one when the Investor is unprofessional or when its knowledge isn’t sufficient
• What are the guarantees: Here it is important to realize – what does this word mean to you? … What importance do you attach to it? It is important to take this question into consideration when deciding between Variant A and B
• Investment amount, another interesting factor for decision-taking
• Huge investments, in milliards SKK/CZK are better to be realized in the system of the Variant A or B
• Smaller investments, when a possible failure is easily eliminated by corporation business, are better to be realized by means of the Variant C or D
• It is important to take into consideration the knowledge of local market, experience with contractors
• Absolute unacquaintance with local market = Variant A or B
• Good knowledge of local situation, experience with contractors already gained from the realization of previous investments = Variant C or D

It is possible to write a lot of recommendations about the system selection. In any case, the Investor has to understand the importance of his decision and, most importantly, the possible consequences of a wrong decision. The managers of our company are experienced in dealing with these problems, therefore we recommend you to turn to the professionals who will be happy to help you.