Guaranteed maximum price contracting A Qualitative study in South Australia

Transcription

1 Bond University Conference Papers 36th Australasian University Building Educators Association (AUBEA) Conference Guaranteed maximum price contracting A Qualitative study in South Australia Tony Ma University of South Australia Phoebe Beh University of South Australia Follow this and additional works at: Recommended Citation Ma, Tony and Beh, Phoebe, "Guaranteed maximum price contracting A Qualitative study in South Australia" (2011). Conference Papers. Paper 8. This Conference Paper is brought to you by the 36th Australasian University Building Educators Association (AUBEA) Conference at epublications@bond. It has been accepted for inclusion in Conference Papers by an authorized administrator of epublications@bond. For more information, please contact Bond University's Repository Coordinator.

2 Guaranteed Maximum Price Contracting A Qualitative Study in South Australia Dr Tony Ma and Phoebe Hooi Wen Beh School of Natural and Built Environments University of South Australia, Adelaide, Australia ABSTRACT The South Australian construction industry is experiencing high demand for new construction and meanwhile increasing project complexities in terms of schedules and budgets. These pressures are driving the need for changes in contracting procedures. The Guaranteed maximum price (GMP) approach to contracting has recently become popular in Australia with a strategy of pre-determining the agreed final contract sum of a project. This study aims to review the current practice and the major components of GMP contracting within the South Australian construction industry. A detailed case study highlights the pitfall of this type of contracting and shows that the standard form of contract is considered necessary for GMP projects as it would provide consistency, in contrast to the current situation with a myriad of hybrid and custom contracts in use. KEYWORDS guaranteed maximum price, standard form of contract, South Australia INTRODUCTION Various types of contracts are available for the construction industry to best procure a construction project. A strategy which is becoming quite popular in Australia is the use of Guaranteed Maximum Price (GMP) to pre-determine the agreed final contract sum of a project. GMP contract is usually used when the scope of work cannot be defined as clearly as in a lump-sum contract. The contractor and the owner agree that the contractor will perform an agreed scope of work which is defined as best as possible at a price not to exceed an agreed-on amount, the GMP (Kaplanogu and Arditi 2009). The typical way of understanding these different types of construction contracts is to view them from the perspective of the amount of risk involved and methods for sharing the risk between parties. The range of risk runs from a fixed-price contract at one end of the spectrum to a totally non risk cost reimbursable contract at the other end of the spectrum (Perkin, 2008). Although GMP contracting has been used for many projects, there is still lacking a standard form of contract for this arrangement. In contrast to the current situation with a numerous of hybrid and custom contracts in use, a proper GMP standard form is an 86

3 obvious solution to provide consistency. Some thought it would be difficult to have a standard form as each project and method of pricing was unique. Another issue is that the contract was generally drafted and administered by the client s representative and what they thought the contract said may not be what it actually said (Davis and Stevenson 2004). The aim of this paper is to review the current practice and the major components of GMP contracting within the South Australian construction industry. A case study has been collected through face-to-face interview. It also attempts to make recommendations for possible standard form for GMP contract. PROBLEMS ASSOCIATED WITH GMP CONTRACTING Gander and Hemsley (1997) defined GMP as: The intention of the Guaranteed Maximum Price contract is to provide a lump sum contract under which there will be no adjustment of the tender price unless the scope required by the client changes. The term GMP when applied to a construction contract provides the client a nice feeling of security. The contractor entering into a contract of this nature is convinced that no matter what happens the final cost will not be above the maximum and there is a fair chance it could be lower (Chan et al. 2004). Any design changes which result from the specific instructions of the client would understandably fall outside the guaranteed price. As mentioned above, this is because GMP contract is considered as a hybrid arrangement consisting of a cost reimbursement contract and a GMP clause implies that the contractor is entitled to be paid an agreed upon fee, reimbursed for his actual cost such that, added to the agreed upon fee, the total amount does not exceed the GMP amount, and compensated for the option accorded through the GMP clause (Boukendour and Bah 2001). With risk transfer being at the moment very much in vogue the guaranteed maximum price contract has seen resurgence. The intention of this procurement route is to transfer all risks to the contractor and allow for no increases in price whatsoever other than costs which result from client changes. Therefore it is always been recommended that a fixed fee is paid and the reimbursable cost includes only the direct cost involved in the work carried out. Hence, the fixed fee is made up of the indirect cost and the contractor's profit, both of which are determined as a function of the scope of work (Boukendour and Bah 2001). According to Tay et al. (2000) and Lim (2001), the major problem encountered whilst using a GMP was the definition of a scope change. If the definition is not well defined, it will certainly fall into the loop hole for disputes and contractual claims. Therefore a well written contract document is of upmost important by describing how the GMP is formulated and under what circumstances that it can be adjusted for scope changes. Davis and Stevenson (2004) noted another problem associated with the use of GMP is no standard form of contract with the myriad of custom contracts that likely causing 87

4 confusion and conflict. The other problems may also include who should be responsible for the errors and omissions in documentations, latent conditions, and disruption due to industrial actions, delays (beyond the control of the contractor) and changes to statutory regulations. Therefore it is recommended that a standard list of items should be developed to ensure that the parties consider them before entering into a GMP contract. MAJOR COMPONENTS OF A GMP CONTRACT GMP contract The basis of administering a GMP contract is usually stated in the contract documents. Due to the absence of detailed and complete tender documents such as a complete set of drawings during the tendering process, negotiation of the contract becomes the primary mechanism between the client and the contractor to form the contract. GMP contract is therefore unique as the various documents transmitted during the derivation of GMP form the part of the Contract Documents. The basic documents of a GMP contract shall include (Lee 1995): Letter and Award Breakdown of GMP sum Summary of Inclusions and Exclusions Summary of Scope of Works Preliminary Architectural, Structural and Landscape Drawings Structural Investigation Report M&E Performance Specifications GMP is estimated based on preliminary design documentation provided by client and his team of consultants (Chan, et al., 2007). The pricing of GMP contracts usually comprises: Cost for main contractor s direct works (e.g. substructure works, reinforced concrete superstructure works, finishes works, etc) Domestic subcontractor s works packages Provisional quantities Provisional sum Contingency for design development The information provided in the tender documents is not sufficient for construction and completion of the works. The contractor is thus allowed in his tender pricing for design development. Further design information will be provided by the client and his team of consultants after the GMP is agreed and issued to the contractor (Turner, 2002). GMP contract generally comprised two basic components; they are Non Adjustable Cost Portion and Adjustable Cost Portion. 88

5 Non adjustable cost portion Although the project brief and the design drawings were incomplete or insufficient for construction and completion of the whole works, the basic scope of the proposed works and their requirements shall be adequately described and defined. The Non Adjustable Cost portion is not subject to any adjustments for any increase or reduction in cost irrespective of actual cost for the works unless there are variations to GMP that were termed as scope changes (Lee, 1995). It is similar to fixed price lump sum contracts without quantity and it comprises components such as preliminaries, cost studies design fees, method statement fees, coordination fees and so on. As the design is yet to be fully developed by the project team, the contractor is significantly required to make sufficient provisions for design development with the knowledge that after the agreement and award of the GMP The Non Adjustable Cost also included the Contractor's compliance with the stringent planning requirement and fire safety regulations (DLS, 2004). Adjustable cost portion Adjustable Cost Portion is for works that are not fully defined during the tender stage. These are typically subcontract works that fixed prices are not readily available during the formulation of GMP. These specialist works, under the control of the head contractor, are to be packaged and tendered to trade contractors. The savings, if any, will be returned to the client and contractor at the end of the project as GMP contracts may provide for sharing in any savings from the GMP allocation (DLS, 2004). However, the methodology to adjust the adjustable cost sum is subject to reduction only. It means that the total actual cost within the Adjustable Cost Portion is less than the sum allocated in the GMP. As indicated by several researchers, the saving sharing mechanism will accrue to the client because it may be argued that if the contractor intends to earn a share in the saving, the GMP that he/she first set may be high in an attempt to have a share in the saving at the end of the project. As a result, the client pays the maximum sum subject to any additional requirement which can only be modified by scope change initiated by the client. If the maximum threshold is unfortunately reached, the contractor has to bear the entire cost. Variations The major problem being encountered is the definition of variations. In fact, the definition of variations is tremendously difficult to manage. It sometimes leads to disputes due to the variations that have a noticeable impact on the final sum of the project. 89

6 There are mainly two types of variations in a GMP contract. The first type of variations is arisen from the design development for which Contractor is deemed to have made provision for within the design risk allowance. Architect s instructions normally will not affect the GMP as it has been included in the provision which is pre-estimated regarding the detail of scope of work is given to the Contractor. On the other hand, the second type of variations to the GMP is scope change. It only occurs when the architect s instruction fall into the situations of materially changes the overall floor plan area or building volume; materially changes the use of an area, and materially changes the level of quality of an area to a higher level of specification from the standard reference (Tay et al. 2000). Costs components in GMP The contractor not only has to provide the total fixed costs and provisional costs, but also has to include the profits and overhead in a reasonable percentage. It also shall include costs associated with: Performance and payment bonds Liability insurance Risk Premium (Optional) Contractor Permit Allowance Construction contingency Professional fees On the other hand, the exclusions are also need to be specified. Below are some of the examples of exclusions: Permanent diversion of services Utilities connection fees Furniture, fittings and equipment items other than those specifically highlighted in the contract. In the General Conditions of a sample construction contract in Adelaide, South Australia, the client does not expect any change order for an increase in costs as GMP only introduced into the contract when the works were 80% completed. Management Contracting has been adopted where the client employs the contractor to coordinate the work packages and to subsequently enter into works contracts with the trade contractors. It is limited to the sums of preliminaries and profit to be quoted throughout the project. Therefore, overhead will be included but are not limited to the followings: Mobilization All indirect salaries for all Construction Manager s employees or consultants who will be involved in the Project 90

7 All expenses establishing and running the field office, including telephone, copier, two-way radios, travel, etc Any miscellaneous tools or materials required for the job All reproduction of documents, surveyor services, testing/inspections, and safety programs/equipment All cleanup of site and adjacent areas, including final clean up Allowance for additional temporary protection/concealment of construction activities if required As-built drawings on paper Demobilization Indirect expenses required for operation of the Contractor s business and all indirect expenses that may be incurred as a result of the performance of the work under Project IS THERE A NEED FOR A GMP STANDARD FORM? Currently there is no standard form of contract classified as GMP. In fact, GMP is a method of project delivery rather than a type of lump sum contract (Haley and Shaw, 2002). The current practice of setting up a contract for GMP is to adapt a traditional standard form with amendments and special requirements to the general conditions of contract (Haley and Shaw, 2002). Another alternative to the client is to produce a bespoke contract. For contractors who market themselves on the fundamental of GMP normally produce their own contract form (Longworth, 2008). A typical example of this is when a Design and Construct contract (AS4000) is used, special conditions related to the formulation of GMP will be added. Any additional risks are then included into the contract scope (Perkin, 2008). Davis and Stevenson (2004) stated the reason of not having a standard form of GMP is that the contract was generally drafted and administered by the client s representative. It is thought what the contract said may not be what it was actually asked by the client. Nevertheless, there is one which comes the nearest is the FIDIC 4 th Edition Red Book, 1999 for use on international projects and although it is not titled as a GMP contract and this is an obvious intention (Longworth, 2008). Regardless of which standard form is to be used, the fundamental principle remains the same. Both client and contractor must fully understand what risks they are assuming. Open discussion about these points should be held so that the components and price in the contract is clarified and understood (Haley and Shaw, 2002). 91

8 From the literature, the Australian Construction Department is increasingly being asked by contractors and clients to set up a GMP standard form which includes the option to use cost reimbursable pricing mechanisms. The standard form should be drafted on a partnering ethos of contracting based on pre-agreed charter of good faith between the parties to effectively cooperate to achieve project s goals. Generally, the agreement is based on trust, respect, open and regular communication and procedures to deal with implementing contract mechanisms include dispute resolution. Therefore, a standard form of contract is considered necessary for GMP projects as it would provide consistency, in contrast to the current situation with a myriad of hybrid and custom contracts in use (Davis and Stevenson, 2004). Moreover, standard forms have been tried in the courts and thus the meaning of the clauses has been tested, and thus solutions will be clearer if things go wrong. In other words, a standard form normally states risk and responsibility allocations clearly hence they must be accepted by the entire contracting parties (Haley and Shaw, 2002). RESEARCH METHODOLOGY A CASE STUDY IN SOUTH AUSTRALIA In order to understand the real issues of a GMP contract in practice, a detailed case study of a recent completed project was conducted through a face-to-face interview with a building procurement manager of a major contractor in Adelaide. The interviewee has 20 years of working experience in the construction industry and came across 7 projects that used the GMP approach. It was a project of Conversion of Former Government Building into Flats. The project particulars are given in Table 1: Table 1 Project particulars Procurement Method GMP by Design and Construct through selective tendering and based on amended AS Partnering Process Nil Pain/gain-share 50/50 gain-share arrangement Reason of Disputation Confusion over the definition of the term Works Nature of project This case study was conducted on a unique and landmark type project involving participants with a reasonable level of previous experience with GMP projects. The method of tendering was selective, in which no partnering was adopted. The procurement mechanism of this project adopted Design and Construct tender approach. It was an arrangement for a 50/50 gain-share agreement incorporated into the procurement process. No pain-share arrangement was stipulated on this project, with any overrun of budget 92

9 solely taken on by the contractor. Time was a major factor on this project as construction had to be undertaken within certain dates in the year. Methods of setting up the GMP contract form This case will illustrate the difficulties which can befall a contractor who enters into a GMP contract. The parties entered into a contract for the conversion of a former government building into flats, including parking and commercial units on the ground floor. The contract was extensively amended based on the AS In particular, an Article A had been added, which provided for a GMP for the carrying out of the contractor's obligations under the contract. Article A also stated the additional risks and responsibilities of the contractor which were to be contained within the GMP at a considerable length. This included that the contractor had satisfied himself as to all risks which might influence or affect the carrying out of the works. These embraced incorrect or insufficient information having been provided to the contractor, any inadequacy or inaccuracy in drawings or specifications, and any other matter irrespective of whether it was foreseeable at the time of entering into the contract. This represented a high level of risk in view of the fact that the work involved the conversion of a building which was almost 100 years old. One of the primary motives for using GMP procurement method was to secure that the contractor would be responsible for the entire construction activities and accordingly that the incidence of contractor's claims would be greatly reduced. Issues of disputation The problem came up once the contractor was issued by the employer s agent of an instruction to carry out the repairs of the concrete perimeter beams within the existing building. In the beginning, it was intended prior to the execution of the contract that tests should be carried out on the structural components, especially with such an old building, to determine their integrity and load bearing capacities. However, no actual investigations had been carried out and no provisions had been prepared for such investigations in the contractor s Proposal. It is not surprising that such a problem gave rise to delay and additional costs incurred by the contractor on such a large and complex refurbishment project. It was argued on behalf of the contractor that there was no specific reference in the Employers Requirement or the Contractor Proposal to the concrete repairs which he was entitled to pay for the work over and above the guaranteed price. 93

10 Mutual discussion A special session had been held for the entire parties involved in this project to discuss who should be responsible for the delay and additional costs incurred. The contractor spelt out that there was no knowing what the contractor might have encountered. The existing structures and foundations, despite a proper pre-contract survey, might have proved to be insufficiently robust to carry the load and to have required strengthening. Commercial organizations who purchased this old property could not sensibly expect to transfer all the risk of the suitability of the property for conversion on to the contractor. On the other hand, the client reckoned that Article A which placed all risks onto the contractor deprived them of any right to additional payment. Furthermore, in finding against the contractor that within the schedule of the guaranteed maximum price, there was nothing to displace the ordinary and unambiguous meaning of Article A that the risk of unforeseen defects in the existing building was the responsibility of the contractor. Without an agreement at the end of the meeting, both parties agreed to refer this matter to arbitration. Arbitration After reviewing the entire contract documents especially the Article A and the hearing of both parties, the arbitrator concluded that it was irrelevant to assume the contract made no specific reference to concrete repairs. In his opinion, the contract contained clear terms for the risk allocation for such unforeseen conditions. He held that all the direct and consequential delay and costs arising from the concrete repairs should be borne by the contractor in his GMP contract. However the contactor did not agree and put forward an appeal to the court for justice. Appeal The contractor argued that the risks they had accepted by reference to one of the clauses and elsewhere in the contract were to be contained within risks arising in connection with the Works. The term 'Works' was clearly defined in the contract and the contractor contended that the repair works to the existing concrete perimeter beams should not form part of his 'Works' under the contract. The contractor also argued that Article A entailed acceptance by it of additional risks and responsibility to that accepted under the other provisions of the contract, but not the risk of rectifying at its own expense any unforeseen defects in the existing building adapted by him. 94

11 Implication Since there was no pain-share arrangement in this project; it meant the cost overrun had to be solely taken by the contractor. Therefore, the contractor appealed the matter to court. The Judge however did not accept this proposition. In his judgment, he indicated that the provisions of Article A clearly allocated the scope of unforeseen or unknown risks to the contractor. Before tendering, the contractor should have considered the information available about the existing building. Moreover, the tendering contractor was to be expected to ascertain the building conditions and to take-up a commercial risk as to the extent of the limited information available. The judge further noted that in any contract with a significant design element at the interface of a building into the ground or on to an existing structure, it was important to allocate the risk of the unforeseen or to ascertain any degree of risk arising out of the ground conditions or existing structure. Consequently, the contractor s appeal failed and he had to solely bear the additional costs incurred by the concrete repair works. Lessons learnt From the commencement to the end of the lawsuit, both parties had spent approximately three years to come to the conclusion, it was time consuming and expensive. In general, the court will not interfere with risk allocation clauses unambiguously written into construction contracts by which the risk of unforeseen events is transferred to one party. However, it is not uncommon for a contract to include in its heading Guaranteed Maximum Price. The fact that this heading exists does not in itself mean that the contractor, except for scope changes, has taken on all risks. Since there is no standard form of GMP contract, clients on domestic projects that require a GMP are left with either amending an existing standard form or having a bespoke contract specially drafted. The one which comes the nearest is the FIDIC Silver Book for use on international projects and AS or AS for domestic projects. Contractors who market themselves on the basis of GMP usually produce their own form of contract. The interviewees suggested that contractor tendering for a GMP contract should be very cautious about the wordings of the contract and to check if the client has transferred all risks to the contractor. It is not unusual to find that matters such as increases in cost due to changes in legislation fall outside the guaranteed price and will be paid for as an extra. Therefore it is time for a standard form of contract for GMP projects to be produced as it would provide consistency and allocations of risk to both parties. 95

12 CONCLUSIONS This research has completed an analysis on the current GMP practice in the South Australian construction industry via a case study approach. As the use of GMP contracts becoming popular, this study provides industry professionals, academics and construction students with a greater understanding of the problems and risks associated with GMP contracts. The current practice of setting up a contract for GMP is adapting a traditional standard form with amendments and special requirements to the general conditions of contract. In order to obtain consistency and minimize the risks for contract administration, a standard form of GMP has become necessary. The fundamental principle remains the same. Both client and contractor must fully understand what risks they are assuming. Open discussion about these points should be held so that the components and price in the contract is clarified and understood before signing the contract. REFERENCES Boukendour, B. and Bah, R. (2001) The guaranteed maximum price contract as call option, Construction Management and Economics, vol. 19, pp Chan, D.M., James, M. and Wong. (2007) Evaluating guaranteed maximum price and target cost contracting strategies in Hong Kong construction industry, Journal of Financial Management of Property and Construction, vol. 12, pp Chan, D.W.M., Chan, A.P.C., Lam, P.T.I., Lam, E.W.M. and Wong, J.M.W. (2007) Research Monograph: An investigation of Guaranteed Maximum Price (GMP) and Target Cost Contracting (TCC) procurement strategies in Hong Kong construction industry. The Hong Kong Polytechnic University, October. Davis Langdon & Seah Singapore (DLS). (2004), Guaranteed Maximum Price Contracts, Executive Summaries for the practitioner, vol. 4(1), MITA (P) No 051/01/2004. Davis, P.R. and Stevenson, D. (2004) Understanding and Applying Guaranteed Maximum Price contracts in Western Australia, in proceedings of Australian Institute of Project Management 2004 National Conference, Perth, th October 2004, Australian Institute of Project Management, Perth. Gander, A. and Hemsley, A. (1997) Guaranteed maximum price contracts. CSM, pp Haley, G. and Shaw, G. (2002) Is "Guaranteed Maximum Price" The Way To Go?, Cannonway Consultants Ltd., Hong Kong. 96

13 Kaplanogu, S.B. and Arditi, D. (2009) Pre-project peer reviews in GMP/lump sum contracts, Engineering, Construction and Architectural Management, vol.16, pp Lee, D. (1995) Guaranteed maximum price contract: the Singapore experience, Singapore Institute of Surveyors and Valuers, Singapore, pp 1-7. Lim, H.K. (2001) Perspective of the construction industry on Guaranteed Maximum Price (GMP) contracting, unpublished thesis, University of South Australia, Australia. Longworth Consulting Worldwide Limited, Guaranteed maximum price construction contract form for contractor. accessed 02/08/ co.uk/news%20construction%20contract%204.htm. Mills, R.S. and Harris, E.C. (1995) Guaranteed maximum price contracts. Construction Law, no. 573/95, Perkin, T.S. (2008) An evaluation of Guaranteed Maximum Price (GMP) procurement strategies and performance in the South Australian construction industry, unpublished thesis, University of South Australia, Australia. Tay, P., MCauley, G. and Bell, B. (2000) Meeting client s needs with GMP, The Building Economist, June, 4-5. Turner, J.R. (2002) Farsighted project contract management: incomplete in its entirety, Construction Management and Economics, vol. 22, pp