Costing of claims in construction contracts
This paper discuss about the costing of claims in the construction industry governed by FIDIC Conditions of Contract. Claim is nothing but the additional benefit arising out of breach of contract conditions / variations etc. In other words, the claims can be classified as the residual part of rights and liabilities.
The Contract is priced on the definite bill of quantities and sometimes the quantity variation is allowed as the final sum is arrived by re-measuring the quantities. In certain circumstances, the Employer / Engineer may ask for certain variations / additional works to the Contractor. Though these works can be measured with existing bill of quantities, the additional time and cost impact the Contractor undergoes can be added to the final value of the variations / additional works. This can only be possible by serving timely notices, giving the details of why the Contractor is entitled the additional time and cost by substantiations etc.
By reading through this paper, one is expected to get a fair knowledge of the various types of costs that can be recovered on account of a feasible claim event. Though by submitting the requisite notices serves an entitlement, the detailed particulars like the impact of the change in sequence, additional works etc on the main work shall have to be substantiated by judicious calculations and submitting the final impact in terms of money and time. Thus understanding the cost carries a vital link to the costing of claims and finally its realization.
KEY WORDS: Claim, Cost, Delay, Disruption, Contract and Construction
In the present scenario of construction industry, the financial achievement to the Contractor is not up to the expectation though most of the projects are executed with quality and within the time stipulated in the Contract. The author has hands on experience on this particular situation while working for various construction contracts. On a close examination of the study revealed that in most of the Projects, the Contractor had executed a number of additional / varied items upon the instruction from the Employer/ Engineer. On account of lack of contractual knowledge on the execution team of the Contractor has caused the non-realization of entitlements by way of Claims.
Though most of the Construction Contract conditions stipulates for recovery of additional cost and time, the realization of the same seems to be very little. The reasons behind this aspect may be the non-awareness of the sequence of operations that to be followed while formation of a claim document. This paper details the various steps one need to follow from identification of claim event till its final submission and realization. This will be a good guide for those in the Construction filed which follows the FIDIC conditions of Contract.
What is a Claim?
A CLAIM is defined as a general term for the assertion of a right to money, property, or to a remedy (2)
Essentially, claims in construction contracts, governed by FIDIC conditions, may be based on any one of the following concepts:
a) A claim under the contract based on the grounds that a particular provision of that contract entitles a claimant to a remedy, which is specified if a certain event, occurs.
b) A claim arising out of the contract based on the grounds that a term of the contract has been breached but where the remedy is not designated (2)
A claim under the applicable law of the contract, based on the grounds of a specific legal rule or principle. If the claim is successful, the remedy is generally a �just and equitable� award, depending upon the particular circumstances of the case (2)
In the claim, the Claimant may seek additional monetary compensation or
an extension of time for completion of work, or both. It is always desirable
that claims are resolved through negotiations. However, when negotiation
fails, the claimant, whether Contractor, Designer or Owner, must resolve
the claim through formal dispute resolution processes such as arbitration
III. PRE REQUISITES FOR SUCCESSFUL CLAIM
A Clear Understanding of the Contract Conditions � Rights and Obligations
The owner and contractor alike have signed the contract and are bound by its provisions. A clear understanding of the contract�s various provisions � affecting the rights and obligations of the parties to the Contract, is essential in order to formulate and process a claim.
Sufficient & Proper Documentation and Records:
Documentary Records will comprise contractual and administrative documents including:
* Tender and Contract Documentation
* Works Record Sheets
* Daily record of labour, plant, supervisory staff, etc.
* Materials received and issued with relevant Orders / Invoices
* Drawings Register
* Correspondence and minutes files
* Site Diaries
* Site Instructions
* Variation Orders
* Additional Works / Day works Register
* Contractual Programme (Cl.14) � Original, and periodic updates as approved
* As built programmes
* Photographs and / or video (preferably with dating facility)
* Agreed Measurements
* Delay Notifications
* Claim Notifications
* Periodic Financial and Cost Accounts
And ---similar documents for major sub contractors.
If the Claimant has all this, then the Claimant will be an excellent position to prove his case. Without this, the Claimant will find it extremely difficult to substantiate otherwise valid claims.
Understanding the Client:
It is essential to understand the Client and his thought process while formulating and presenting a Claim. Various alternatives should be assessed, and the alternative finally chosen must be such that the Client / Engineer feel most comfortable with it, and he is able to justify the claim without compromising his position.
A Claim is nothing more or less than an unresolved change request. These unresolved change requests usually contain major elements that both sides can agree upon. If agreement is reached, and appropriate consideration is given for these mutually agreeable aspects of the dispute, the remaining issues often become non- issues due to cost- benefit considerations, and the claim is resolved. That should be the goal of both sides in negotiating construction disputes.
IV. THE CLAIM DOCUMENT: - FORMATS & CONTENTS
The success of a good case for a claim can often turn upon a well presented document. A claim is basically a document, which sets out to persuade. Claims documents need to be produced with top quality print, well reproduced graphics, and with an introduction which invites the potential reader to look inside and read the case.
In most cases, the burden of proving any given claim rests with the claimant; he who asserts must prove. Claims must therefore be adequately documented.
The recipient of the Claim Document is highly unlikely to have the time and motivation to study and understand a poorly presented claim document. When presented with an ill prepared document, the recipient, no matter how unbiased he may consider he is, will think to himself: �why should I spend my valuable time examining this document when the person presenting it to me has not taken the time and trouble to prepare a decent document?�
A well presented claim document will normally have the following distinct sections, and will be framed as under:
(ii) Contractual basis of the claim
(iii) The details of the claim
(iv) The evaluation of the claim
This section shall contain salient features of the contract, relevant milestone events, brief background details of the claim, and the justification for entitlement (in brief) and the amount / remedy sought.
(ii) Contractual basis of the claim:
It is of vital importance to spell out precisely on what contractual basis the claim is founded. It is also essential to state clearly the event or events pertaining to the claim. References to notifications, which have been made during the contract, can be made in this section.
(iii) The details of the Claim:
This section should provide full details of all clauses and corresponding effects. The three key phrases that are used in this section are �delay�, �extension of time� and �costs� (money!). It is also important to remember that delay does not always bring an entitlement to an extension of time, and that granting of an extension of time does not always bring money.
It is always advisable to summaries all correspondence pertaining to delays. As far as possible, the document should be read through and be complete in itself. To this end, when references are made to correspondence in the narrative of this section, it is essential to attach relevant copies of the correspondence to the claim in the form of one of the appendices. If reference is made to a programme, it is essential to append a copy of the programme to the claim. It is desirable that the appendices can be read simultaneously with the narrative. If something can be represented graphically, it is better to do so. It will be easier for the reader to understand the point made, than if the same were to be stated by a long and rambling narrative. The aim of this section is to provide a logical link between the cause (of the problem) and its effect. This section must ensure that this is done. Contemporaneous records in the form of reports, diary entries, correspondences and minutes of meetings, can be extremely useful in establishing the causal nexus.
(iv) Evaluation of the Claim:
In this section, the claim is evaluated as to �cost�. This section will give reasonable details of the work out of costs for each and every �head� of costing that is relevant to the claim. It will justify, using commonly accepted norms / standards and industry practices, the money value of the claim or the amount claimed by way of remedy.
As stated earlier, various references essential to the claim, but which cannot be put in the earlier sections of the claim document for the sake of clarity and presentation, will be found in the appendices. It is essential that the appendices are properly indexed and cross referenced.
V. DELAYING EVENTS � TIME, COST AND NOTICE PROVISIONS
Figure - 1
Reproduced from �FIDIC 4th- A Practical Legal Guide� by E.C. Corbett
These events leading to claims, and in fact, most construction claims, can be categorized into four broad groups:
a) Claims due to extended stay at site due to delays / disruptions
b) Claims due to variations and change orders
c) Claims due to unforeseeable physical conditions
d) Claims due to increased costs on account of ordered or constructive acceleration.
a. Claims due to extended stay at site due to delays /disruptions
The contractor would generally incur additional indirect cost on account of extended stay at site (It is presumed that the quantum of works has not increased). In other words, since the time spend at site by the contractor has increased, when compared to what was envisaged at Tender Stage, �Time� related costs would generally increase (3)
The following costs are increased:
Indirect manpower engaged in the works like office boys, watch and ward staff, stores personnel, plant maintenance crew etc., supervisory costs such as salaries of managers and other supervisory and administrative staff.
Ownership costs for the extended period, or hire charges if the equipment is leased from other parties.
Power & Fuel:
The consumption for colonies, camps, general services etc.
Insurance & Financing costs:
These costs would be incurred due to extensions of Bonds, insurances & guarantees as well as deficit cash flow generally caused by long delays or disruptions.
Other Revenue expenses, which are time related, will also increase.
Reduced Contribution to Head Office overheads:
This is traditionally calculated by the Hudson�s formula or the Eichleay formula (3)
b. Claims due to variations and change orders:
The most important aspect of the valuation of such a claim is that a proper time and motion study is required to be prepared for the varied or additional work with particular stress on labour productivity, equipment productivity and use / wastage of materials in the work. The benefit of such variations can be maximized by a getting the client to accept the norms that are most favorable to the contractor. Contemporaneous records have a very vital role to play in such a claim.
Valuation of such claims can take various forms. For such an exercise, normally the contract provides guidelines (e.g. clause 52 of the FIDIC conditions (1)). The rates for the work will be normally compared with existing or similar rates available in the Contract. In absence of such rates, the contractor will be required to present a build up of rates based on the actual expenditure on manpower, equipment & materials along with mark up for overheads & profit (1). The productivity of all these resources will be subjected to scrutiny by the client based on acceptable norms
In this type of a claim, the main emphasis is on the direct cost element. A portion of the preliminary expenses can also be added (generally as lump sum provision) while for the Overheads and profit (Indirect cost) a percentage of the prime cost is added. Such a percentage is generally available in standard norms which may vary from 15% to 25% of the prime cost
c. Claims due to unforeseeable physical conditions:
The costing of such a claim is dependent on the steps the contractor takes to counter such a condition. The contractor may introduce additional equipment and manpower for overcoming these situations. The contractor may be required to carryout new items of work, or he may be required to adopt a new methodology for carrying out the work. In such cases, the direct costs will play a major role in accounting for a change in applicable rates / increased costs. If the project suffers time delays, then the element of indirect costs also plays a significant part in quantifying the claims (3)
d. Claims due to increased costs on account of ordered or constructive
This type of a claim is associated with induction of additional resources used for acceleration. For providing the eligibility under such a claim, a contractor would need a frame or reference. Such a frame of reference would normally be the Construction Programme and methodology submitted along with the Tender. Many Tender offers do require the contractor to declare the manpower and equipments envisaged at tender stage. These provisions could be established in the Clause 14 programme / Method statements (1). In case the acceleration is ordered by the client, the case would be relatively easy to prove
There may be cases where a contactor has applied for extension of time, and the Engineer has not granted such extension of time, and on the other had, issued notice under Cl.46.1 of FIDIC (1) .In such case, the contractor is obliged to increase his resources and complete the project by the original completion date. If the contractor can subsequently establish his case for time extension, such a case would be defined as constructive acceleration.
VI . COST
Cost is defined in FIDIC (1) as:
�Cost means all expenditure properly incurred or to be incurred, whether on or off the site including overhead and other charges properly allocable thereto but does not include any allowance for profit.� (1)
Cost is also a relative term, and depends on perspective. For example, if a contractor agrees to build a facility for an Owner for a sum $ 100 Million in two years, the two entities will look at this cost of $100 Million in a different manner:
For the Owner:
The Cost will generally be in the nature of a Capital Cost, or an Asset. This cost shall cumulatively increase over the period of two years, as represented by the �S� Curve, in this diagram, where if all goes as per schedule, he will have spend a total of $ 100 Million over two years for the facility.
Figure - 2
For the Contractor:
No part of the amount of $100 Million will be capitalized. The amount of $ 100 Million will represent the turnover for the contractor over two years. For costs, the Works valued at $ 100 Million, shall be split up as under:
Figure - 3
Costs are traditionally divided into three Main Groups:
* Direct Costs
* Indirect Costs
* Preliminary & Enabling Costs
Direct Costs may be further sub divided into Direct Labour, Direct Material, Direct Sub Contract, Direct Power and Fuel.
The term �direct� is used, and the expenses so classified, when the expenses can be attributed precisely or with reasonable accuracy to an item of payable work. These costs vary in direct proportion to the volume of payable work executed.
These expenses include costs on Labour, Material etc. which cannot be attributed to an item of payable work but are general in nature; in addition, expenses on equipment (ownership and operation), salaries of managers and supervisory staff, site running expenses, revenue expenses, insurance costs, financial charges, etc. are also classified as indirect expenses. The basic criteria are that indirect expenses are mainly a function of �time� rather than a function of �progress�.
Preliminary and Enabling Expenses:
These are generally expenses incurred on site installations like housing / hutting, plant foundations, water & power lines and other enabling works. These expenses are not necessarily one �time expenses; the criterion that is applied is that the benefit from these expenses would be of an enduring nature. E.g. air lines, water lines and ventilation ducting in tunnels. These costs are generally amortized over the life of the project such that all preliminary expenses are fully charged at 90% of project completion.
How are these Costs and their classification relevant of Construction Claims?
The various types of events leading to time and cost implications under the FIDIC provisions are:
VII. ELEMENTS OF CONSTRUCTION COSTS:
The main elements of construction costs are as follows:
> Manpower Costs
> Equipment Costs
> Material Costs
> Financial Costs including interest
> On Site Indirect Costs or On Site Overheads
> Off Site Indirect Costs or Off Site Overheads
> Risks, Contingencies & Margin
Preliminary and Enabling Costs � These costs are actually the reclassification of the above elements, depending on the nature of the expenses.
Manpower costs comprise the cost of labour � both direct and indirect labour and the cost of supervisory staff including managers. The costs included the wages and salaries paid on the basis of payrolls, and benefits- both statutory, and perquisites extended by the company. Manpower costs would also include the cost of recruitment and repatriation especially for seasonal labour, and retrenchment and other compensation paid to workmen.
The manpower can be ascertained from the payrolls / wage records and such records can be used to substantiate these costs if necessary
Direct labour cost is generally used in claims for variation / additional items of work or whenever payable items of work are concerned. This cost is allocated on the basis of man-hours or man days per unit of work, which is usually to be agreed with the client on the basis of contemporary records. If a Day work (1) schedule for labour rates forms a part of the contract, it is generally more advantageous for the Contractor to use these rates for valuing the direct labour component of the varied work.
In cases of disruptions (3) where no works can be done for a significant period of time and the contractor is not in a position to re deploy such labour on other works, or repatriate his labour force, either due to the inordinately high cost involved in such repatriation, or that the contractor would not find suitable labour once the disruption ceases, the manpower cost for this retained workforce can reasonably be claimed as idle wages.
If there is a delay (3) in the works, resulting in a lesser progress than planned as per the agreed construction programme, the contractor, in any case, has to incur the full cost of his direct labour. In this scenario, the contractor is entitled to claim such additional costs occasioned by the reduced productivity of his direct labour.
In a claim for acceleration, whether direct or constructive, the contractor can claim the cost of additional direct labour man days or man hours that he has introduced in the works for the purpose of such acceleration.
The price adjustment clause would normally cater for the increase in the Direct Labour cost occasioned by rise in the cost of living / general inflation and price variation clause specifically debar claims on these accounts.
Indirect Labour Costs comprise the cost of services rendered by office boys, watch and ward, store helpers, survey boys, and workshop maintenance crews. These costs are generally used in Claims for extended stay and disruption.
The cost incurred on managerial, supervisory and administrative staff falls under this element of cost. These are indirect expenses, and generally not linked to work progress. These costs are also generally used in claims for delay and disruption. However, if in a varied or additional item of work, it can be demonstrated that such item of work required additional or special supervision, such additional supervision shall become a direct cost element for valuation of that particular varied work.
Equipment introduced on a project would be of two types:
1. Company�s own equipment
2. Hired equipment
While working out the equipment costs the factors to be considered are as follows:
1. Ownership Costs
2. Operation / running costs
3. Repairs / Maintenance Costs
In case of extended stay claims, the contractor is required to provide the equipment on site for a period longer than originally envisaged. In case of only disruption (3), the equipments will be idle. The contractor will nevertheless incur the Ownership Costs, which can be put up as a claim. However, in case of a delay (3) (slow progress of works), not attributable to contractor, he will incur all three types of costs, which need to be compared with the original estimate. Such incremental costs can be put up as a claim. In cases of Variations / additional works, wherever payable items are concerned, the cost is allocated on the basis of use rate of equipment per unit of work which is usually to be agreed with the client on the basis of contemporaneous records. However in case of new equipment to be introduced for changed scope of work / method of construction, the unit cast needs to be worked out from first principles considering all three types of costs enumerated above (2) .
In a claim for acceleration, whether directed or constructive, the contractor can claim the Ownership, and Repair costs of additional equipment resources that he has introduced in the works for the purposes of such acceleration. The running costs of the contractor are deemed to be recovered from the payable works at Bill of Quantity rates (2).
The elements of material costs are as follows:
1. Basic material cost
2. Relevant Taxes
3. Handling / Transportation costs
The market prices of materials may change during course of any delay / disruptions (3) that the project may suffer. However, the work involving these materials, whenever executed, will be paid at Bill of Quantity rates plus escalation (1) at that point of time. The change in basic material prices are deemed to be covered by the escalation formulae and thereby cannot form the subject matter of a claim related to time lag. However, in case of a change in specifications / substitution of the material / increased wastage(due to factors beyond the contractors control), the contractor may compute the additional differential cost, which can be the subject matter of a valid clam.
However, a special case for a claim would arise in the case of perishable materials, not utilized during their shelf life, due to a delay not attributable to the contractor. In such a case, the contractor would be entitled for a rightful claim as to the total costs of the materials damaged (2).
Interest / Financing Charges:
The contractors may be required to fund the project at times of negative cash flow, from borrowed money, either from their Head Office or outside sources. The contractor also bears the charges for providing Guarantee bonds / Insurances for the duration of the project.
In case of delays / disruptions (3) in progress, the contractor will be affected on two accounts:
1. Adverse affect on the cash flow for self sustenance of the project
2. Maintenance of Guarantees / Insurances for a period, longer than envisaged
Adverse Cash Flow and Interest.
Interest or �the cost of money� is often a major element of construction claims. Interest of Financing Cost (2) to a contractor can be substantial where there are large unresolved claim disputes. Since most Contracts require a contractor to proceed with additional works even though a final price for the change has not been resolved, a contractor�s cash flow is often significantly impacted, and it becomes necessary to borrow funds to keep the works going. Since resolution generally taken a long time, the contractor has to finalize his works for a long period. The interest can be calculated on the basis of the deficit shown in the cash flow. Interest can be compounded at market rates of interest at monthly or quarterly intervals (2)
Maintenance of Guarantees / Insurances for a period, longer than envisaged
In such scenario, the contractor can claim the increased charges for such instruments based on the actual market rates which can be substantiated with letters / certificates from the concerned institutions.
The overhead expenses are categorized as:
1. On � site overheads
2. Off-site overheads (Head Office Overheads)
On � site overheads
On- site overheads or Jobsite Overheads will encompass the various indirect costs incurred at site, i.e., supervision costs, administrative costs, site running costs, and other revenue expenses like postage, telephones, stationery, conveyance & traveling expenses, office expenses etc. These costs are seen to be totally time rated and thereby stand to be claimed in any workout related to additional costs on account of approved time extensions.
In case of variations that do not affect the time duration of the project, the on site overheads will not be affected and thereby not claimable from a theoretical point of view. However, if it can be demonstrated that the variations required additional supervision costs and it can be proved with contemporaneous records, this additional costs can be claimed.
Off - Site Overheads
These overheads are also called Head Office Overheads. These costs, which arise out of overall company management, are well recognized as a recoverable cost. These overheads are continuing expenses, which are allocated to the contractor�s various contracts on a total job cost basis. These are also called �share of Head Office Overheads�, which cannot be allocated to a particular contract.
Hudson Formula: (3)
H.O / Profit Percentage x Contract Sum x Period of Delay
100 Contract period
Eichleay Formula: (3)
1. Contract Billings x Total Overhead for Contract period = Overhead
Total Billings allocable to Contract
In actual Contract Period
2. Allocable Overhead = Daily Contract Overhead
Days of Performance
3. Daily Contract Overhead x Number of days delay = Total unabsorbed Head
The profit element in a claim is not recoverable, as it does not fall in the determination of cost as per the FIDIC provisions.
However, in case of variations / additional works the profit element can be added to the workouts, since the mark � up on prime cost is allowed for �overheads and profit�.
Risk, Contingencies and Margin
Risk is a combination of the probability or frequency or occurrence of a defined hazard and the magnitude of the consequences of the occurrence (2). Hazard is defined as a situation that could occur during the lifetime of a product, system or plant that has the potential for human injury, damage to property, damage to the environment, or economic loss (2)
Contingencies are the cost provided by the contractor to cater for some unforeseeable events (2). Normally this is expressed as a percentage to the total cost of the works.
Margin is the percentage of earning the contractor planned to gain from the project (2)
To conclude, costing of claims is one of the critical areas in any construction industry. As discussed in detail in this paper, the process and procedure of claim management in construction starts with understanding the concept, basis of claim, keeping the supporting documents, serving the Notices and detailed particulars within the stipulated time, co-ordination between the people, proper allocation of the cost and finally appreciable presentation. By adopting the right steps at the right time will definitely enable one to fulfill the contractual entitlement. The author through his past experiences urges all Project Team Members to be acquainted with provisions of Contract in particular of the various Notice provisions towards successful realization of justified entitlement.
IX. LIST OF TABLES / FIGURES:
1. Delaying Events �Time & Cost Notice Provisions- Figure 1 � Page 7
2. Understanding of �COST� for the Owner � Figure 2 - Page 10
3. Understanding of �COST� for the Contractor � Figure 3 � Page 11
FIDIC - Federation International Des Ingenieurs-Conseils is one standard form of conditions of contract for Engineering Works which is accepted all over the world. FIDIC is the international Federation duly elected associations of consulting engineers representing the profession in their respective countries (1)
CLAIM is defined as a general term for the assertion of a right to money, property, or to a remedy (2)
RISK is a combination of the probability or frequency or occurrence of a defined hazard and the magnitude of the consequences of the occurrence (2)
HAZARD is defined as a situation that could occur during the lifetime of a product, system or plant that has the potential for human injury, damage to property, damage to the environment, or economic loss (2)
CONTINGENCIES are the cost provided by the contractor to cater for some unforeseeable events (2)
MARGIN is the percentage of earning the contractor planned to gain from the project (2)
(1) Federation Internationale Des Ingenieurs �Conseils; The Conditions of
Contract for Works of Civil Engineering Construction 4th edition,
1987 reprinted 1992.
(2) The FIDIC Form of Contract � The Fourth Edition of the Red Book,
Second Edition by NAEL G. BUNNI - A Blackwell Publication.
(3) Society of Construction Law; Delay and Disruption Protocol; October
2002, reprint October 2004