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Types of Contracts

In the oil & gas, petrochemical, power plants and such other energy related sectors, for the engineering, construction and services requirements, there are fundamentally three types of Contracts that are used for engaging Contractors. These are:

  • Lump Sum Contracts.
  • Reimbursable Cost Contracts.
  • Measured Work or Measured Term Contracts.

The element that receives the highest consideration prior to the selection of any of the above type of Contract strategy to be employed for Works/Services is, risk. If a Contractor is able to work with a definite known scope of work and specifications, risks of unknowns are minimum and therefore he would be more willing to accept a lump sum Contract factoring risks for cost and schedule overrun, otherwise reimbursable or Measured type of Contract would be more suited.

Risks are inherent in any type of Works and Services and they should be examined in terms of those risks are controllable/manageable and those that are not or those that one cannot pass on. Lesser the risks one is able to manage under a Contract, more likely is one willing to accept a lump sum Contract and vice versa.

A summary of the various types of Contracts are:

Lump Sum Contracts

In a Lump Sum Contract, the Contractor is required to provide upfront for all risks and costs for performing to Contract defined requirements and, no variations are allowed during execution. Contractor is responsible for cost and schedule overruns. Lump sum Contracts are highly effective where the scope, design and specifications are well defined with a high degree of certainty as a result of which risks are minimum.

Lump sum Contracts could be further categorized into broad types viz.:

  • Turnkey;
  • Fixed Lump Sum; and
  • Build Operate and Transfer (BOT).
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Turnkey Contracts

Under the Turnkey Contract, the Contractor has total responsibility for the design, engineering, procurement, construction, installation, and commissioning (EPC) of the plant/ facility against a Client defined statement of requirements (SOR) or performance. The Client has little if any, involvement in the technical selection or specification of technical solutions to meet its obligations. Client’s role could be reduced to monitoring Contractors’ performance against agreed milestones to enable payments of lump sum amounts as the Work progresses or on completion, depending on terms agreed.

Fixed Lump Sum Contracts

Unlike the turnkey, under the lump sum type, Contractor performs to Client defined scope, specifications and design. The Client has full control over key aspects of the Contract with respect to the scope, selection of appropriate technologies, designs and such other parameters. Fixed lump sum prices are agreed for a very well defined scope, design and specifications and no variation to the Contract Price is allowed except in case of Client requested variations in parameters that are significantly different than Contract requirements. Payments to Contractor are either based on defined milestones or on progress work measurement or a combination of the two.

Build-operate-transfer (BOT)

Another type of Contract that is on a very high degree, bizarre, turnkey concept but much different than the ones discussed above is the “Build Operate and Transfer (BOT) Contract”. BOT Contracts are normally used for large infrastructure projects normally involving large financial expenditures. Examples of which could be construction of dams, desalination plants, water treatment and disposal plants, power plants, roads, bridges and such other projects. In a BOT Contract, the Contractor builds the facility, operates it for a while and thereafter transfers it to the Client upon recovery of costs expended in construction. In some others, the Contractor hands over the facility to the Client at a particular stage of the financial recovery cycle and thereafter the Client purchases the end product at a fee till the Contractor recovers its full investment plus profit. In cases the facility could remain a property of the Contractor and, the Client shares the investment costs on a certain financial basis.

Though in a Turnkey type of a Contract the Client could have some influence on the choice of technology or other factors, but in the case of a BOT Contract the Client has virtually no choice or control in the selection of any of the elements of technology or specifications. The BOT Contract is presented only for understanding and is beyond the purview of shankce.in.

Reimbursable Cost Contracts (or Reimbursable Contracts)

In situations where the scope is ill defined thereby not enabling a Contractor to commit a lump sum price or where the Client requires an early start of work at site pending full definition of requirements, a (cost) reimbursable type of a Contract is adopted. Under this type the Contractor is reimbursed costs and paid fees on the basis of Work actually done. The Client takes control of the management and utilisation of Contract resources due to which minimal risk is assumed by the Contractor. Since it does not obligate the Contractor to devote any specified level of effort there is little incentive to minimise cost and schedule to the Client.

Therefore, to make such Contracts effective, appropriate bonus payments to Contractor in case the Contract is completed within time and/or agreed cost, could be considered.

The price administration mechanism is rarely uncomplicated, needing an elaborate Contract Administration and accounting system to track invoices paid, cost/rates analysis, review of supporting documentation for star rate items, etc. thereby making them the most expensive type to administer and less cost efficient. On the other hand, they offer significant flexibility and work start could be achieved almost immediately.

Reimbursable cost Contracts embrace many variations and forms. In addition to reimbursement of its actual costs, the Contractor could be paid a fixed fee that includes overheads and profit in either of the following ways:

  • Cost plus fixed fee; or
  • Cost plus fee based on performance; or
  • Cost plus a percentage of final costs.
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Measured Work Contract or Measured Term Contract

The third, a combination of the lump sum and cost reimbursable type of Contract is the Measured Work Contract or Measured Term Contract. It is used where:

  • the scope of work is known but the extent not or
  • the scope is not clearly known and also unknown is the fact that the work would be carried out in the first place at all or not.
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Measured Contracts come in two forms:

Schedule of Quantities or Bill of Quantities (BOQ)

Under a BOQ Contract, Client requires Contractor to perform works where the design and specifications for units of works are defined but the total extent of work is not defined. Under this type, unit rates for standard work units are agreed and Contractor reimbursed normally at fixed all inclusive rates based on the quantities actually completed at site, as measured.

Schedule of Rates (SOR)

SOR type of Contract is primarily used in term (plant) maintenance Contracts where Contractor is required to provide work over a period of time. Under this type, the scope of work is not precisely known. Thus an exhaustive list or schedule of rates is drawn up to include all possible work items, so that the Contract is not starved of rates if required to be used upon completion of work.

Due to its very nature, this type is very cumbersome from the point of view of the Client’s administration as, the schedule of rates should be elaborate enough to include all items of works and, describe in detail all possible work items with specifications that could be required in the future. A typical example could be employing a Contractor for maintenance of a fractionation column in a refinery. Since the quantity and type of repairs/rectification work to be carried out could be: assessed only upon partial dismantling and inspection of the column, the schedule of rates should contain in as much detail as possible, all works that could potentially be required for such repair/rectification. Due to its complex and cumbersome nature, such types of Contracts should be employed where the Contractor is highly experienced and has prior knowledge of site and work conditions.

Thus the type of Contract to be adopted for a requirement should be identified early on i.e. at the Contract strategy and Bidder list approval stage, in order to determine the level of definition required and hence the setting up of the Client organisation and the allocation of resources to meet downstream activity schedule.

To reiterate, the fundamental principle behind adopting a particular strategy is based on; better the definition of scope, design and specifications at Tender stage, the more likely is one able to award a lump sum Contract, with confidence which will not be subject to undue changes, variations or amendments during execution. At the same time considerable effort, time and cost would be spent in defining requirements to readily facilitate a lump sum Tender. Where a proper scope definition is not available, reimbursable forms such as cost plus fees, bill of quantities, schedule of rates or other type Contracts may be more appropriate.

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