Contracts (Archived)

RT-005 Topic Summary
RT 005

Overview

Studies were performed by the Construction Industry Institute (CII) to determine ways to increase construction effectiveness by improving the contractual relationship between the owner and contractor. CII’s Contracts Task Force conducted several studies to investigate construction contract types and clauses (RS5-1), incentive plans (RS5-2), and risk allocation and cost effectiveness (RS5-3).

The aim of the studies was to assess the impact of contract type and contract clauses on key project performance factorssafety, quality, cost, schedule, and satisfaction of owner and contractor. The results of the studies were based on responses from in-depth questionnaires sent to CII members (mix of owners and contractors) spread across several industries.

Well-written construction contracts tailored to the circumstances of the project and based on total agreement between both parties are essential to successful project performance, owner/contractor relations, and cost effectiveness.

No single type of contract is best suited for all projects, but thoughtful preparation of the contract, with balanced input from all parties, is always necessary. Factors that should influence the contract type include the level of definition of the work, fast-tracking to accelerate completion, need for flexibility to make changes during performance of the work, owner’s effort and expertise, and marketplace conditions. Clauses related to work scope definition, changes, and project controls are frequent sources of disputes, and care must be taken to clarify these clauses as necessary. Any inconsistency or ambiguity must be rectified early to avoid later misunderstandings, delays, and increased costs.

Risk allocation must be tailored to the circumstances of the project to realize the cost benefits. Imbalanced risk allocation between owners and contractors will incur higher project costs. The risk allocation on fixed-price contracts is most problematic and was the focus of the studies. Four specific aspects of contract risk allocation were addressed in the task force’s report: indemnity, consequential damages, differing conditions, and delay. Inequitable risk burden on the contractor for each of these aspects is not cost effective for the owner. It is important for all parties involved in the project to be educated on the implications of risk allocation on project performance, and on the differences in contract administration required for cost-reimbursable and lump sum contracts.

Contract incentive plans are a useful mechanism to increase construction cost effectiveness for cost-reimbursable projects and should be employed when possible. To be effective, the incentive plan must be carefully designed to include appropriate features for the project, set fair expectations, and balance contractor motivation for each aspect of the project. Considerations for effective incentive plans are:

  • Balance between unilateral (set by owner) versus negotiated (set jointly) plans
  • Positive versus negative incentives
  • End-of-project outcomes (final outcome) versus milestone determination (intermediate outcomes)

Establishing a positive owner/contractor relationship is crucial and can be achieved by opening communication channels between the owner and contractor, and by giving authority to owner onsite project managers to make decisions at a level closer to the work.  A well-written contract that is agreed upon by all parties will help promote and maintain this working relationship, keep costs at a minimum, and improve overall project performance.

Key Findings and Implementation Tools

1 : Problematic Contract Clauses

The nine most problematic clauses fall into three main groupings: (RS5-1, p. 4)

  • Work Scope Clauses – issues involve errors, omissions, ambiguities, and inconsistencies
  • Change Clauses – issues involve definitions, dispute resolution, negotiation of costs, and approval timeline
  • Project Controls Clauses – issues involve mechanisms to monitor and approve project performance
  These categories of clauses caused issues in both fixed-price and cost-reimbursable contracts.
Reference: (RS5-1)

2 : Contract Clauses

Contractor and owner views, motivations, and incentives often conflict. Many do coincide, but there is at least potential for conflicting objectives. Contract clauses that do not fit the realities of a situation may promote a conflict of interest. (RS5-1, p. 5)
Reference: (RS5-1)

3 : Contract Type

The type of contract (fixed-cost vs. cost-reimbursable) should be heavily influenced by five factors: (RS5-1, p. 10)

  1. The extent to which the work is defined
  2. The desired allocation of risk between owner and contractor
  3. The availability of owner expertise and effort on the project
  4. The need to accommodate fast-tracking of design and construction
  5. The general marketplace conditions
Reference: (RS5-1)

4 : Risk Allocation

Contract risk allocation is influential to project success. Each aspect, including indemnity, consequential damage, differing conditions, and delay, must be carefully considered and balanced by both the owner and the contractor. (RS5-3, p. v)
Reference: (RS5-3)

5 : Owner and Contractor Differences

Significant differences were expressed by owners and contractors about those clauses that were most troublesome, and about the risk allocation effect of those particular clauses. There is a prevalent owner practice of using contract language to shift risk to the contractor. There are problems with ambiguity in risk allocation clauses, as evidenced by owners and contractors having different perceptions of the effect of such clauses. Contract preparation that allocates risk with a balanced input from all parties is the most cost-effective. (RS5-1, p. 7)
Reference: (RS5-1)

6 : Incentive Plans

Incentive plans demand more precise definition of project objectives by owners, which may in turn result in better design definition. There must be a balance between quantitative and qualitative measures and parameters used in the design of incentive plans. (RS5-2, p. 6)
Reference: (RS5-2)

7 : Incentive Plan Benefits

Survey results strongly suggest that properly designed and administered incentive plans will yield total project benefits to the owner greater than the program’s cost. Positive incentive clauses enhance project performance, while negative incentives hamper performance. (RS5-2, p. 11)
Reference: (RS5-2)
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Key Performance Indicators

Improved cost, Improved schedule, Improved performance/achieve success, Reduced/improved risk, Improved craft productivity

Research Publications

Impact of Risk Allocation and Equity in Construction Contracts - SD-44

Publication Date: 03/1989 Type: Source Document Pages: 437 Status: Archived Reference

Contract Risk Allocation and Cost Effectiveness - RS5-3

Publication Date: 11/1988 Type: Research Summary Pages: 18 Status: Archived Supporting Product

Incentive Plans: Design & Application Considerations - RS5-2

Publication Date: 11/1988 Type: Research Summary Pages: 18 Status: Archived Supporting Product

Unique Features of Construction Contract Incentive Plans - SD-40

Publication Date: 10/1988 Type: Source Document Pages: 221 Status: Archived Reference

Impact of Various Construction Contract Types and Clauses on Project Performance - RS5-1

Publication Date: 07/1986 Type: Research Summary Pages: 18 Status: Archived Supporting Product

Analysis of Construction Contract Change Clauses, Volume II - SD-15

Publication Date: 04/1986 Type: Source Document Pages: 136 Status: Archived Reference

An Analysis of Construction Contract Change Clauses, Volume I - SD-14

Publication Date: 04/1986 Type: Source Document Pages: 116 Status: Archived Reference

Determining the Impact of Various Construction Contract Types and Clauses on Project Performance, Vo - SD-11

Publication Date: 04/1986 Type: Source Document Pages: 227 Status: Archived Reference

Determining the Impact of Various Construction Contract Types and Clauses on Project Performance, Vo - SD-10

Publication Date: 04/1986 Type: Source Document Pages: 185 Status: Archived Reference

Contract Clause Study Data - SD-9

Publication Date: 04/1986 Type: Source Document Pages: 17 Status: Archived Reference

Incentives in Construction Contracts - SD-8

Publication Date: 04/1986 Type: Source Document Pages: 132 Status: Archived Reference


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