American
Bar Association
Forum on
the Construction Industry
Incentives
and Disincentives in Construction Contracts
A Contractor’s Perspective On Their Use in Large
Contracts
Nancy
Taylor
Senior Counsel
Bechtel
Power Corporation
October 25
& 26, 2007
Hyatt
Regency Newport Hotel & Spa—
©American Bar Association
INTRODUCTION
Lawyers negotiating construction
contracts representing contractors for large projects are often called upon to
negotiate project specific contractual terms and conditions with the goal of obtaining
agreement to final terms and conditions that provide an overall mutually
acceptable balance of risk and reward for both parties in the context of the
specific project in question. One of the
practitioner’s chief undertakings is to assist their negotiating team in
analyzing and appropriately applying various incentive and disincentives within
the framework of an overall commercial deal and looking critically at the economic
and other drivers that may be associated with utilizing specific incentives or
disincentives for a specific contract or deal.
While understanding what may or may not
qualify as an incentive or disincentive in a contractual context is imperative,
and frankly, is very dependent upon which side of the table one sits on during
the negotiations, practitioners and their business and management teams on both
sides of a large construction contract negotiation are called upon perhaps most
importantly to understand how incentives and disincentives work together to
framework an overall deal.[1]
With that goal in mind, this paper will examine and compare how a sample
of various incentives and disincentives may work together to framework a deal
in a manner that promotes achievement of what should be one of the primary
goals in any major construction project – that being to ensure (as best as
possible) that all parties to the transaction retain a shared mutual interest
in achieving timely and successful project completion and a sound business
return, with the allocation of specific risks to each of the parties that are
best able to manage or account for such risks.
EXAMINATION
OF CONTRACT STRUCTURES
There are of course many competing
factors which go into the negotiating parties’ determination of which form of
contract is appropriate for a specific large project at hand, including, but
not limited to, general market dynamics, size and scope of project, technology
issues, financing issues, schedule requirements, and the like.[2]
As the lump sum and cost reimbursable contracting approaches are
typically thought of as being on opposite spectrums of possible contracting
structures, we will focus on these two deal structures and examine how
incentives and disincentives typically work in each of these structures.
I. The Lump Sum, Turnkey Contract Structure
The Lump Sum Turnkey or “LSTK”
contracting structure provides project owners with a single point of
responsibility for the engineering, procurement and construction (“EPC”) of a
large project. Generally speaking, the
contractor assumes all major projects risks, with the exception of those risks
commonly accepted to be beyond a contractor’s control such as force majeure,
change in law and the like, in exchange for a single, lump sum price that includes
a premium for the contractor’s assumption of such risks.[3]
This model was first utilized for power generation projects.[4] Generally speaking, this model is best suited
to projects that involve a very well defined scope of work with little
anticipated need for change(s) (e.g. construction of a gas fired combined cycle
power plant with output of certain megawatts, target heat rate, target
availability, etc), mature technology, stable economic market conditions, and
relatively finite project duration.[5]
A. Contractor Incentives
1. Lump
Sum Pricing Includes a Built In Risk Premium Which Is Translated into
Contractor Profit if the Project Is Successfully Executed
As the LSTK contractor is responsible for
the performance and the timely completion of the project in question for a
fixed price, the LSTK contractor must “stand in front” of or “wrap” the
performance and schedule of a multitude of subcontractors, including major
subcontractors and vendors who provide the manufactured goods or processes
required to for the project in question.
The LSTK contractor also generally takes the risks of quantities, labor
availability and productivity, raw materials pricing, and the like. In certain instances, certain major
components supplied for a project will have a stand alone guarantee provided by
the equipment supplier which may or may not be wrapped by the LSTK contractor.
Given the above, the LSTK contractor’s
final lump sum price will include contingency dollars to deal with the
“expected” difficulties many projects encounter. If, however, a project is executed as
planned, unexpended contingency dollars will translate into additional profit,
to be retained by contractor. In
addition to contingency, the LSTK contractor will also include a fee or profit
component in its final lump sum price.
In exchange for offering the project owner turnkey services and the
increased risks associated therewith, the LSTK contractor is often able to
command a higher fee as opposed to other contracting structure.
2. Costs
Saved by “Value Engineering” are 100% realized by Contractor.
While LSTK projects require detailed scope definition, once the contract is signed and the project begins execution, the LSTK contractor will likely have opportunities to "value engineer” the project and thereby reduce costs.[6].
Thus, the LSTK contractor may, for example, optimize project layout in a manner that reduces the aggregate quantities of bulk items such as piping, cables, concrete, et cetera utilized for a project or may utilize new or existing internal or proprietary design approaches that lead to greater efficiencies in the field – such as requiring equipment vendors to pre-assemble components in the factory in order to expedite to decrease field construction hours and optimize the project schedule, thereby avoiding field costs or “houseloads” estimated and included in the LSTK price. Alternatively, the LSTK contractor may be able to leverage superior buying power with its vendors to obtain project inputs for less than the amount included in the estimate used to arrive at the LSTK price.
The ability to investigate and implement the foregoing measures requires that the LSTK contractor has broad latitude, subject to compliance with the specified project scope, to plan, schedule and carry out the project in accordance with its internal work processes, with little interference from the project owner. In addition, it should be noted that owners and project lenders nevertheless do retain a significant ability to influence contractor performance via the setting out specific progress milestones upon the achievement of which the LSTK contractor is entitled to receive corresponding progress or milestone payments.
Whatever the method used, the lump sum contract by its nature provides a tremendous incentive for contractors to achieve project optimization as all construction cost savings are to the benefit of the contractor, thus, in the abstract, further improving the financial return for the LSTK contractor who can successfully implement value engineering efforts.
3. Schedule/Performance
Bonuses
Typically, LSTK contractor include
liquidated damages assessable if the project is delivered after an agreed to
guaranteed schedule or if the project fails to satisfactorily achieve
guaranteed performance parameters. As
these provisions are implemented to protect owners against significant negative
financial impacts from problems with project delivery and performance, the
sophisticated LSTK contractor recognizes that many project owners may
conversely improve their financial returns on a project if the project is
completed earlier than scheduled or demonstrates better than guaranteed
performance and often successfully argues for a performance and/or schedule
bonus.[7]
There are a variety of ways in which a
schedule or performance bonuses are measured.
Generally, a schedule bonus will be an agreed upon amount of money that
a contractor would be entitled to receive for each day a project is completed
prior to an agreed to completion date.
Similarly, a performance bonus will be an agreed upon amount of money
that a contractor would be entitled to receive with respect to each category of
guaranteed performance (e.g. for a power plant project, heat rate (fuel
efficiency) or power output (megawatts generated)).
However, whether the economics of a
project are improved by the project coming on line earlier or having better
than guaranteed performance is a function of the specific project.
For example, if the project is financed,
an owner may recognize a significant savings in interest during construction if
the project is delivered before its guaranteed delivery date. There may also be very discrete project
specific dynamics which inform this question as well. For example a project may realize a one time
tax benefits if it comes on line early.
Similarly, certain projects -- such as a “peaker” gas fired power plant
built to run only during times of peak demand in the summer or winter – may
have an opportunity to earn unanticipated revenue that greatly improves the owner’s
financial model and returns if it can be made available prior to any specific
peak revenue earning period.
Alternatively, let us posit that a
contractor delivers a power plant with power output that is five percent (5%)
better than guaranteed. Theoretically,
the owner should earn additional, unanticipated revenue for these megawatts
over the many decades of anticipated useful life of a power plant.[8] However, if the project owner has entered
into a power purchase agreement[9],
and the purchaser or “off-taker” can not utilize this additional power output,
better than guaranteed performance may be of no economic benefit to the owner
and a performance bonus would not be in order.
Knowledge of the project’s economics and
a properly developed incentive scheme can lead to greater alignment of interest
in outcomes during the execution phase.
Thus, a contractor without prompting by the Owner may elect to spend
money to accelerate the project schedule if the contractor is aware that early
completion is of benefit to the owner.
If the same were true but Contractor was not entitled to a schedule
bonus, the contractor likely would not elect to accelerate the project
schedule.
4. Step
Down In Limitation of Liability and Retainage/Security Requirements Prior to Full
Project Completion
The
LSTK contractor will seek an aggregate limitation of liability for its
responsibilities under the contract.
There is of course a tension between contractors and owners on this
point, with owners often seeking unlimited or extremely high (e.g. 100% of the
contract price) limitation on the aggregate liability of the contractor and the
contractor seeking a much lower percentage.
An approach for dealing with this tension is to seek a middle ground
which provides owners with a high(er) limitation of liability until an agreed
upon point of project completion. For
example, at the point of “Mechanical Completion”, the major construction risks
have been averted or sufficiently addressed to give the owner a reasonable
indication that the project has been physically installed and upon achievement
of Mechanical Completion, the contract will provide for a reduction in the
aggregate limitation of liability. This
approach answers both parties’ interests in affording owner heightened protection
in the most uncertain early stages of construction while affording a contractor
with sufficient protection against concerns about maintaining heightened
exposure even after the point where a contractor has successfully performed the
majority of its project obligations.
Similarly,
an LSTK contractor often must agree to allow the project owner to maintain a
cash retainage of some portion of the contractor’s payments or to provide cash
equivalent securities to provide the owner with assurances of performance. Each of the foregoing result in real costs to
the contractor’s bottom line.[10] The ability to alleviate or avoid these costs
maintains a contractor’s ability to optimize its limited financing/security
resources across a portfolio of projects.
Similar to the foregoing discussion on limitations of liability, the
amount of contractor security should equate to risks at given point in the
construction of a project – thus as completion nears, risks associated with the
project completing should lessen and the owner’s security requirements should
allow for a step down.
5.
Payment Assurances
As the sole point of responsibility for a
project, in addition to the vast outlays for its own internal employee costs,
the LSTK contractor undertakes significant financial exposures to third party
subcontractors and vendors that are multiples of a contractor’s profit return
on the average project. If an owner
fails to pay contractor amounts due under the contract, in most instances, the
contractor’s obligations to such third parties remain unchanged. This is a most disquieting proposition for
contractors. Thus, payment assurance is
clearly a concern of paramount importance to an LSTK contractor as agreed to
project costs must be for the account of the owner.
In a project financed project,
contractors typically require confirmation that the financing party has fully
funded or committed all funds to pay the agreed to LSTK price prior to
commencing work. As discussed in greater
detail below, payment milestones help to ensure that the LSTK contractor has
only limited exposure for payments due to subcontractors and third parties
involved in the project construction. Thereafter,
while the LSTK contractor must progress the work to receive payments, the
contractor at least has assurances that funds to pay costs in accordance with
the contract are available.
However, if a project if financed with
less than full funding or is self-financed by an owner using the strength of
its balance sheet, a contractor needs to maintain adequate assurances that it
has full recourse to an adequately financed or capitalized party and/or should
the financial condition of the foregoing party change, have the ability to
obtain a cash equivalent security. There
are several guaranty and security mechanisms to achieve this result including a
guaranty from a parent entity with a strong balance sheet or a letter of credit
if the financial strength of the entities involved is not sufficient from the
perspective of the LSTK contractor.
6. Broad
and Well Defined Change Order Rights
As previously provided[11],
the LSTK contracting model can only be used when the contractual scope of work,
the division of responsibility and any key assumptions relating to the
foregoing have been very clearly defined by the contracting parties. However, even within the bounds of a well
defined LSTK scope, parties must make provision to allow the contract to
recognize and compensate contractor for a change when there is a departure from
the as agreed to project baseline.
Examples of conditions that traditionally
give rise to a change condition in an LSTK contract include items such as force
majeure events[12], governmental
actions/inactions and/or changes in law, unreasonable owner interference or
owner failure to perform any retained obligations.
Increasingly, however, it is becoming
more difficult for parties to identify an agreed to project baseline for large
infrastructure projects lasting over a four to five year time horizon. For example, national and world wide economic
and other dynamics have caused sharp and unanticipated price volatility for raw
materials and labor unavailability.[13]
These are not the type of risks that lend themselves well to lump sum
pricing as, other than charging an even more significant risk premium, a
contractor has no effective way to pre-determine the impacts of large volatile
dynamics on the ultimate project cost and schedule. This has increasingly led negotiating parties
to agree to alternative pricing mechanisms within the overall LSTK construct. Examples of these alternate pricing
mechanisms include cost-sharing components such as price escalation clauses for
raw materials and other project inputs.[14]
The failure to pay close attention to and
to anticipate these market dynamics has caused more than one previously
successful contractor to go out of business.[15]
B. Contractor
Disincentives
1. Misaligned
or Onerous Payment Terms; Payment Withholdings
The successful LSTK contractor must
insist upon a payment schedule and terms that results in receipt of payments
for project costs fairly contemporaneously with their expenditure. If this is not the case, then the LSTK
contractor will in effect “finance” the project.
As the typical LSTK contractor already
has numerous risks to manage, it is inadvisable for either a contractor or
owner to agree to payment terms that would result in the contractor financing
the project and postponing owner’s expenditure as long as possible. This approach is a perilous one and instead
of reaping rewards for owner in avoided costs could have the unintended effect
of jeopardizing successful project completion.[16]
A typical approach under LSTK contracts is
to provide for a significant down payment at the start of a job.[17] Thereafter, the contractor should receive
periodic (monthly ideally) pre-agreed payments based either on overall progress
or achievement of pre-agreed milestones.
An owner is typically entitled to
withhold all or a portion of a payment associated with incomplete or deficient
progress or failure to achieve stated milestones or conversely, drawdown
securities or utilize retainage to address contractor malperformance. The ability of the owner to exercise these
rights is a powerful disincentive to a contractor continuing any course of
malperformance. The LSTK contractor
typically is not entitled to stop work in the event of an owner
withholding. In turn, as the single
point of responsibility, the LSTK contractor must continue to satisfy its
financial obligations to vendors, its houseload costs and the same.
In addition, the LSTK contractor is
frequently required to provide security in favor of the owner for the
contractor’s performance. Accordingly, a
drawdown of such a security or utilization of retainage is also a powerful
disincentive to the contractor. However,
as with payment, great care need be taken in the LSTK contract to pre-agree to
the conditions under which an owner would be entitled to take such steps. Failure to do so could result in the
contractor’s security and retainage amounts being utilized by an owner as an
additional source of financing for the project.
2. Schedule
and Performance Liquidated Damages
Liquidated
damages assessed against the LSTK contractor typically fall into two broad
categories (i.e. delay/schedule liquidated damages and performance liquidated
damages).
The LSTK contractor typically must pay
schedule liquidated damages if the project fails to achieve a pre-agreed
completion milestone roughly equivalent to the point in time at which the
project can be put to beneficial use substantially in accordance with the
owner’s planned usage.[18] The term “substantial completion” is used in
many industries to denote this turnover milestone. Similarly, the LSTK contractor must pay
performance liquidated damages if the project fails to achieve certain
pre-agreed guaranteed performance parameters within a certain period of time
after the guaranteed completion date.
Schedule liquidated damages are usually
expressed as a daily amount to compensate an owner for its genuine estimate of
losses or damages its will suffers as a result of each day of completion delay. Such costs typically include increased
financing costs, costs that may arise under or in respect of third party
agreements or obligations (such as liquidated damages under a power purchase
agreement, “take or pay” obligations under a gas supply agreement, regulatory
fines and the like)[19]. Performance liquidated damages on the other
hand are expressed as a value per unit of lost performance and compensate owner
for the net present value of the revenue foregone over the useful life of the
project in respect of the subject performance deficiency.[20]. In the power sector, performance liquidated
damages may be calibrated to shortfalls in capacity (megawatts), heat rate
(conversion efficiency of the fuel (e.g. natural gas or coal) into electricity
output, and availability.
Typically,
the limitations of liability on performance and schedule liquidated damages are
in excess of the LSTK contractor’s projected profit on the project. Thus, in order to avoid disputes at the end
of the project regarding the application of imprecise contractual language, it
is of the utmost importance that the parties have a clear documented
understanding of and agreement to not only the various components that will be
included in their formulation, but also the various events that will trigger
their assessment.
For example,
with respect to schedule liquidated damages, a contractor typically has full
care, custody and control of a project until substantial completion. Upon achievement of substantial completion,
it is typical for schedule liquidated damages to no longer be assessable with
respect to any further milestones. Once
the owner has operational control of the project, the contractor’s schedule will
typically take a back seat to the project’s operational demands. Thus, a contractor typically will only agree
to schedule liquidated damages tied to a milestone at which the contractor will
have maximum unimpeded rights to schedule work and other latitude to complete
the necessary work.
Similarly,
with respect to performance liquidated damages, great care should be taken to
select performance guarantees that can in large part be achieved over
relatively short periods of time as opposed to relying on extended periods
where owner operational mistakes or maintenance failures may lead to failed
performance results. Thus, for example,
the LSTK power plant contractor typically is responsible to demonstrate
performance guarantees for heat rate, output, availability and the like over a
series of relatively short testing periods (several hours to thirty days as
opposed to a year).
3. Broad/Extended
Warranties on Completed Work
The LSTK Contractor is typically required
to give a broad warranty that the project will satisfy certain prescribed
warranty standards for some period after the project is turned over to the
owner. This period is typically 12 to 24
months.[21] Typically, if a warranty defect arises due to
any service, workmanship or component performed or supplied by contractor or
any of its contractors being non-compliant with contractual requirements, the
LSTK contractor must address the warranty deficiency at its own cost.
It is typical for parties to agree to
exclude certain conditions from the contractor’s warranty obligations. Thus, normal wear and tear, items
necessitated by normal maintenance and the like or defects arising from the
owner’s failure to operate the project in line with operational requirements
are typically excluded from warranty coverage.
Similarly, once under owner’s care, custody and control, it would be a
typical contractor’s expectation that the owner would maintain operating
insurance policies to respond to any downstream equipment damage that may be
caused by a warranty equipment defect.
The LSTK contractor with broad warranty
remedies will seek concomitant warranty coverage from its major equipment
vendors to deal with the attendant risk.
In addition, the LSTK contractor may also require that one of its
employees remain at the project site during the warranty period to ensure that
it is kept aware of day to day operational issues and potential warranty issues
in real time.
4. Rights
of Rejection
While not the norm for the majority of
LSTK projects, in certain industries and markets, LSTK contracts will include a
draconian right for the owner to “reject” the project if it fails to reach
certain prescribed minimum performance requirements by the end of a cure
period. This is then coupled with obligations
for the contractor to repay all amounts received under the contract, to
disassemble the project and to restore the project site back to its
pre-construction condition.
From a contractor’s perspective, this
disincentive is viewed as potentially creating fundamental misalignment between
a contractor and owner in that creates a possibility in which an owner may no
longer be invested in the successful completion of the project and thus would
not be motivated to find solutions to problems on a project as they arise. These types of provisions effectively allow
an owner to revisit its investment decision at the contractor’s expense should
there be an economic downturn coupled with project execution challenges.
II. The Cost Reimbursable Contract Structure
There are numerous variations on the cost
reimbursable contract, such as: (i) the
cost plus fixed percentage contract in which a contractor is entitled to all
costs expended plus a percentage of such expenditures; or (ii) the cost plus
fixed fee contract, which is much like the foregoing, except that Contractor
pre-agrees to a fixed fee which would not increase due to greater than
anticipated project expenditures.[22] Whatever the particular model chosen, the
hallmark of the cost reimbursable contract is that the contractor no longer
bares sole responsibility for the project costs and any overrun thereof.
Opposite of the lump sum contract, the
cost reimbursable contract is appropriate where there is perceived market
instability, lack of all encompassing scope definition, new technologies,
and/or owner desire to direct and oversee major decisions and day to day
performance of the project construction.[23]
Recent economic dynamics and market trends suggest that the cost reimbursable contract may become more prevalent in industries in which they were heretofore not the preferred model.[24] Large, publicly traded engineering and construction firms increasingly highlight to their shareholders that they seek to achieve a balanced portfolio of cost reimbursable projects with lump sum projects making up only a slice of that portfolio.[25] Other large private contractors have also recently entered into large cost reimbursable contracts.[26]
A. Incentives
1. Owner
Maintains Project Costs Overrun Risks and Rewards
The owner in a
cost reimbursable contract maintains the majority of the project risk
associated with pricing overruns. Thus,
the contractor’s pricing approach on a cost reimbursable project is going to be
leaner and the owner has at least a potential of realizing unspent anticipated
project costs. Thus, while it is always
prudent to include contingency in any final construction budget, should that
contingency not be spent, such unexpended amounts will typically be for the
owner’s account in a cost reimbursable project.
2.
Contractor
Guaranteed a Profit on the Project
As mentioned above, the contractor’s
profit or fee is either a fixed percentage or fixed amount agreed to as part of
final contract negotiations. In
addition, the contractor in a lump sum contract may many times also negotiate a
discretionary fee that may be realized for better than guaranteed performance
(e.g. on schedule, project costs and the like).
Commensurate with the relatively lesser quantum of risk undertaken by
contractor, this fee component is typically a lesser percentage of the total
project costs than it would be were the project to be performed on a lump sum
basis. However, with a fixed fee, the
contractor has an a priori guarantee that it will make at least some profit on
a cost reimbursable (albeit reduced as when compared to a lump sum job).
3. No
“Wrap” Responsibility/Liability and Limited Responsibility for Rework
The contractor in a cost reimbursable
project does not typically offer one stop liability coverage for all
construction risks. Owners typically
enter directly into agreements with major third party vendors and specialty
subcontractors directly. In addition,
the reduced cost reimbursable pricing does not allow the contractor any
effective tool to cover malperformance by other third party service or
equipment providers.
Similarly, for the same reasons as above,
it is atypical for a cost reimbursable contract to include liquidated
damages. Moreover, the contractor’s
responsibility or liability for defective work is also typically much more
circumscribed. The cost reimbursable
contract often times requires an owner to pay for the performance and
reperformance of all defective project work until the beginning of a warranty
period, at which time the contractor typically would undertake circumscribed
warranty liability. For example, the
cost reimbursable contractor may agree to reperform its own services but would
not be responsible or would have extremely limited liability for costs
associated with any field rework or equipment repair or replacement arising due
to a subcontractor’s warranty defect.
It should be noted however that the cost
reimbursable contracting model however is a flexible model and if provision of
some level of “wrap” responsibility is an important feature to an owner, there
are methods through which inventive negotiating teams can devise terms which
mimic (albeit on a limited basis) ‘wrap’ responsibility for the overall project
results. For example, a contractor may
place at risk some portion of its fee or may have ability to earn a
discretionary fee or bonus if the project achieves on time or advanced delivery
or better than guaranteed performance.
4
Expedited
Payment Terms
As the owner
maintains all or the majority of pricing risks associated with the project, and
does not have the benefit of any payment of contingency to deal with potential
non-payments, the cost reimbursable contractor will often require payment terms
which are expedited when compared to the lump sum contract. Thus, in the cost reimbursable contract
achieving payment terms that result in the owner’s payment of project costs in
real time or even in advance of such costs being incurred is of critical importance. Expedited contractor rights to suspend or
terminate work in the event of non-payment are often coupled with cost reimbursable
payment provisions.
B. Disincentives
1.
Guaranteed
Maximum Pricing
The guaranteed maximum price contract
structure works as a hybrid between a cost reimbursable contract and a lump sum
contract. Under a guaranteed maximum
price contract, a contractor is compensated on a reimbursable basis until the
project costs reach a pre-agreed ceiling.
After that point, all costs in excess of that ceiling are to the
contractor’s account.
In many ways, for a contractor this is
the worst of all worlds. The contractor
effectively takes the residual cost overrun risk while not enjoying the benefit
of any costs saved by value engineering efforts, all of which would typically
be for the owner’s account, while receiving the lower financial returns
typically associated with a cost reimbursable project.
This structure sets up a misaligned or
uneven sharing of risks and rewards as an owner receives benefits – either in
the form of avoided costs saved if the guaranteed maximum ceiling in not
reached or in the form of shifting responsibility for all costs to contractor
one the ceiling is reached.
A far better approach to ensuring that a
contractor remains committed and focused on managing the costs in a cost
reimbursable contract is the use of a target price cost reimbursable
contract. The target cost approach
requires that the parties agree to a lump sum target against which both parties
will seek to manage overall project costs.
If final project costs are less than the agreed to target, the parties
would share on a pre-agreed basis the benefit of any savings. Conversely, if the final project costs are in
excess of the target, then the parties would share responsibility for cost
overruns also on a pre-agreed pro rata basis.
2. Limited or No Change Rights
Many cost reimbursable contracts contain
no or extremely limited change rights due to the mistaken belief that
pre-agreement to change conditions is unnecessary as the Owner is responsible
for reimbursing all project costs.
However, sophisticated contractors are
interested in completing the cost reimbursable project on time and under
budget. If the contract is set up
correctly, this result will improve the contractor’s profit return on the
project. In addition, the large
contractor has significant reputational concerns that almost inevitably lead to
such contractors managing the cost reimbursable contract in much the same
manner as the lump sum contract. Thus,
setting a project baseline and pre-agreeing to conditions which are a change to
that agreed-to project baseline is just as important on a cost reimbursable
project as it is on a lump sum project as the parties need to maintain a common
understanding of the baseline from which project success or failure should be
measured.
Conclusion
The selection of contract structure in
and of itself prescribes the incentives and disincentives that will drive the
parties’ interests, behaviors and concerns in large business deal. Careful attention needs to be paid to ensure
that these incentives and disincentives are fashioned in a way that motivates
the parties on each side to continue to work for successful project completion.
[1] See
Christof von Branconi & Christoph H.
[2] For discussion of factors to consider in
selecting contractual structures, see,
e.g., C.T. Harris, J. Formigli, B. Crager,
[3] For discussion of lump sum contracting structure and
other contracting structures, see Chris Hendrickson, Project Management for
Construction: Fundamental Concepts for
Owners, Engineers, Architects and Builders, ch. 8 (Version 2.1 ed.,
2003), available at http://www.ce.cmu.edu/pmbook/.
[4] Harris, supra note 2.
[5] See, e.g., Daniel Atkinson, Contract Strategies in Construction Projects, Atkinson Law (Nov. 15, 2001, updated May 3, 2006), http://www.atkinson-law.com/cases/CasesArticles/Articles/Contract_Strategies.htm; Harris, supra note 2