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Need for better contract design, structure and management

Efficient contract design and management have always been grey areas across infrastructure sectors. This has also resulted in a lot of disputes and thus there has been an increasing need for dispute resolution and arbitration. It is important that the contracts prepared are aligned with project-specific requirements so as to prevent disputes.

At a recent webinar organised by India Infrastructure on “Contract Design, Structure and Management”, industry experts discussed the key considerations that need to be taken into account while designing and structuring a contract, evolution of contract design over the years, and the changes needed in contract design, structure and management. Excerpts…

Aakanksha Joshi, Partner, ELP

The contract structure basically determines how we allocate the risks and returns between different parties. With regard to engineering, procurement and construction (EPC) contracts, there is a lot of design risk. Large and complex contracts have a number of subcontractors and sometimes they interfere with each other. Such a risk needs to be addressed.

There is a need to relook at the design of the contract, making it simpler, so one does not have to go to a lawyer to understand one’s obligations. Then, there are issues related to notifications as well. Thus, it is both a matter of contract management and contract design and there is a need for a responsible collaborative system to help resolve such disputes and issues. Globally, there is a concept known as alliancing, where both parties regularly discuss issues that come up in the project, which may be a step in the right direction.

Close attention should also be paid to the scope of work and greater clarity is required with respect to the scope. The hybrid annuity model (HAM) is a concession contract wherein construction risks are mitigated from the perspective of a private developer, as 40 per cent of the cost is paid up front during the construction period. In India, as far as I know, the HAM model is generally used in the road sector, where it is easier to construct and maintain the road assets, and where most of the risk is during the construction period. Under the build-operate-transfer (BOT) model, there are land acquisition issues, design risks and challenges related to complex projects and technologies.

Brigadier Amit Kathpalia, Head, Training and Product Development, RICS South Asia

In construction, there are various types of contracts in use. The key point to consider is that the right contract is being selected and for the right reason. The four kinds of contracts we use as far as construction projects are concerned are item rate, lump sum, EPC and cost-plus contracts, though cost-plus is rarely used.

Often the wrong model is used for a project. In a lump sum contract, it is the employer who decides the design but instead of giving the rate of every item, he gives the drawing and specification and the contractor has to work out the costs from the drawings. So, this becomes a lump sum fixed price contract.

There is also a design and build contract. The basic difference between a design and build contract and an engineering, procurement and construction contract is that in the latter, every kind of risk is transferred to the contractor as all the data needs to be checked and verified. Under the design and build contract, the design is with the contractor but the employer provides the base data of the site, verifies the drawings at various stages, is responsible for the accuracy of the base data and there is a reasonable amount of risk sharing.

The International Federation of Consulting Engineers (FIDIC) has a huge set of 55 books. The major one is the red book which is traditionally an item rate contract. Then there is the yellow book where the major portion of the design is done by the contractor but the employer monitors it very closely. So, for the contractor, there is less risk and less entitlement too. In an EPC contract, the contractor takes all the risk but he has greater entitlement too.

According to FIDIC, there are three conditions wherein EPC contracts should not be taken up. First, if there is insufficient time for a contractor to undertake site investigations; second, if the project involves substantial underground work (as it can never be predicted fully); and third, if the employer wants to supervise and monitor all drawings and approve the work done by the contractor very closely. Another condition which may be added to this is if the contract is likely to involve substantial variations.

Puran Kumar, Head, Contract Management, Larsen & Toubro

Currently, we are working mostly on EPC contracts. Though all the risk rests with the contractor, where the contractor designs, procures and constructs, there is hardly any freedom given to the contractor in design. In the private sector, each builder has his own contract. We are comfortable working with an EPC contract, provided it gives better rewards for the risk taken and greater freedom with respect to design.

In India, the concept of an EPC contract is yet to settle down; people still prefer to operate in the item rate mode of contract. The five important points that need to be addressed to make the EPC contract successful  are: unambiguous provision of scope of work, freedom in design, no change of scope after 50 per cent of original time, timely provision of right of way including shifting of utilities/cutting of trees and payment terms in line with the money spent.

Sanjoy Mukherjee, Executive Director (Projects), Engineers India Limited

When we started doing contracts for public sector undertakings, we were involved in item rate contracts, where we undertook total design and detailed engineering and gave the construction drawing to the contractor only to implement at the site.

However, due to tight project schedules, clients perceive that they have limited time to implement the project. At present, we are providing project management consultancy services for one of the biggest institutional campuses in the country, which is being implemented on EPC basis. We have been involved with the basic design engineering and the contractor has to do the detailed engineering and get it approved by Engineers India Limited, after which the construction work will be taken up. As a result of the time schedule, we had given the basic design engineering in the bid document itself.

There is no mandate by the government as to what kind of contract should be executed on an EPC basis. But it is accepted that when time is limited, EPC contracts work better since all the parameters are fixed in the tender and the contractor has to stick to these parameters. For EPC contracts we generally do topographical surveys and investigations and these reports are part of the tender documents. So far, we have found that EPC contracts are well implemented by contractors.

With regard to claim settlements, if there are claims that are not aligned with the contract document, we try to analyse them as per the document and give clearance to them as soon as possible. Generally, we try to resolve disputes internally so they do not go into arbitration.

Sudip Mullick, Partner, Khaitan and Co.

There are various types of contracts such as BOT, cost- plus, build transfer, EPC and HAM. In an EPC contract the requirement of change and extra work should be restricted and/or very stringent. The contractors’ entitlement, interim and final, time and money, for the owner’s requirement of change and/or extra work should be simplified and realistic. With regard to contractors claim for change and / or extra work, the notification provisions by the contractor/owner and mandatory written instructions should be adhered to both legally and morally, otherwise it gives rise to issues like waiver, relinquishment and estoppel. The continuous interference in EPC contracts by owners and the delays that happen (because of the supposed checks and balances) should be reduced considerably which would benefit both the owners and contractors. Determination of issues related to force majeure and interaction with other contractors appointed by the owner in the same project causes many issues. So, I would say, the engineering in-charge and project managers are very important, but their role should be to act as a completely independently rather than only protect the interest of the owners.

Under HAM, 40 per cent of the money is paid upfront by the government and then the balance is collected, so the contractor’s risk is reduced substantially. In BOT, however, all the risk is transferred to the contractor. Though BOT is good from the government’s point of view, I think HAM is the flavour of the season.

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