1

SOME ASPECTS OF
CONTRACT
ADMINISTRATION

By

M.Sridhar
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SOME ASPECTS OF CONTRACT ADMINISTRATION

1.0 Introduction:
As some one rightly said the first two decades of the new millennium in India,
belong to Civil Engineers because of the growth in spurring industrial activity and all
around infrastructure development. All such construction activities are undertaken
through contracts whether it is a Government Organization or a Private Commercial
Enterprise. There are various types of contracts like Item rate contracts, percentage rate,
Lump sum or Turn key, EPC contracts and cost plus contracts.

All participants responsible for project executions - Owners, Contractors,

Consultants etc. have realized the need and necessity of efficient administration of
Contracts entered in to, for execution of project. This only will ensure timely execution
of projects by which litigations will be minimal, slippages in schedules, time and cost over
runs can be curtailed. It is disheartening to note that as per a Survey made, in India, in
construction industry, the amount locked up in litigations at various stages is around
Rs.50, 000.00 Crores. The leading construction houses with swelling order books and
almost doubling of operations by way of new contracts each year have recognized the
Contract administration as a new and separate discipline distinct from Project
Management.

The Contract administration currently is viewed as a profession based on codified

knowledge rather than a skill. In olden days it emanated from good practices and
approach followed by some successful professionals and veteran field engineers. More
precisely this discipline is a blend of technical and legal subjects.

Some do synonimically use the word contract management for contract

administration. Contract Management has a close relation to Project Management and
virtually refers the same. But for administering of the contract understanding of some
legal principles is required.

Contract is a set of promises made by parties with legally binding obligations,

duties with conferring rights. In true sense the contract can only be administered and
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which cant be managed. One can simply refer the meaning and difference in functions
of Manager and Administrator for this aspect.

Now let us look at some legal and technical aspects of this subject in subsequent topics.

2.0 Contract Act:

All the contracts are governed by law of contracts and will be within the preview of
Indian Contract 1872. There is no provision in the law to state that the contract must be in
writing except that the Arbitration agreement, if exists in the contract. Law specifically
states that the Arbitration Agreement must be in writing as per the Arbitration Act.

The term Contract is derived from latin word Contractum which means drawn
together. Thus a contract is defined as an agreement creating and defining obligations
between the parties.

Section 2 (h) of the Indian Contract Act 1872 defines contract as an agreement
enforceable by law is contract.

Normally while referring the construction contract we use the terms contract and
agreement interchangeably. But the above definition suggests that there is a subtle
difference between two.

Fundamentally an agreement is nothing but a promise or set of promises. All such

agreements are not contracts. Only those agreements which create legal obligations and
are enforceable by law are Contracts. The term enforceable by law implies that an
agreement must, fulfill certain conditions so that it is recognizable by law as a Contract.
Thus when it is a contract, then only the court can enforce it under the Contract Act.

Some of the essential conditions of a valid contract are enumerated below:

1. Minimum two parties: There must be minimum two parties for a valid contract.

2. Consensus Ad idem: This term means there must be Identify of minds between
parties for entering in to agreement.

This is an essential bed rock for a valid contract.

Both the parties should have clear in mind the same subject and object of the
contract. Suppose A has two houses one at Hyderabad another at Vizag and offers
to sell his house to B. Say B assumes that the house of A at Vizag is for sale
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(but A intends to sell the house at Hyderabad) and makes an agreement for
purchase of house (of course place not mentioned) then such contract is void since
there is no identify of minds between parties.

If there is a mistake or misrepresentation of facts by one of parties, while entering into an

agreement, such contracts can be proved void.

(Section 17, 20-22 of contract Act can be referred in detail)

3. Consideration: The agreement should be for a lawful consideration. Consideration may

not be always in monetary terms but some thing in return. An agreement without
consideration is void. A enters into agreement with B to construct his house for
Rs.10.00 Lakhs. Here the consideration of A is Rs.10.00 Lakhs for B it is his house.

Consideration can be present, past or future.

A made an agreement with B for subletting part of his contract work in consideration to
form future business partnerships and joint ventures with B. This consideration is valid to
make a lawful contract since by offering some thing A is also expecting some thing in
return, in future.

4. Free consent: The consent of the parties to the agreement must be free, given by
the free exercise of ones will after his own judgment regarding terms and conditions.

If the consent is induced by coercion, threat, undue influence then the contract is null and
void.

(Section 15, 16 of contract act can be referred for details)

The above list of criterion for valid contracts is not exhaustive and touches those aspects
relevant to construction contracts only .
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3.0 Making of a Contract:

Normally in the process of entering into, construction contracts , the client
referred as Owner or Employer first invites the bids by issuing tenders which may
consist conditions, specifications, details of proposed work, drawings, data and BOQ. The
bidder based on this data, information will submit the tender with relevant particulars
quoting his price which is termed as Offer. The offer has a specific validity period, after
which it lapses.

After evaluation of bids the Owner communicates the acceptance of offer.

Once the acceptance of offer is communicated, legally there is a binding contract arising
between the parties. Signing of agreement by parties is only a formality and part of
documentation process.

The parties may negotiate on the original offer in which case the negotiated offer is
accepted .
But, the acceptance shall be absolute, unconditional. Suppose if the owner invites the
bidder for negotiations for price reduction which is termed as counter offer by other
party and for example the bidder keeps silent . The owner has now made a counter offer
which requires a confirmation by bidder yes or no. In this case the original offer is no
longer valid for acceptance after such a counter offer.

Offer
Invited Bid

Owner Bidder
Owner Bidder Counter /Negotiations
Offer Offer

Confirmation
Acceptance

Acceptance
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4.0 Types of contracts:

Here the types of contracts are categorized based on mode of operation and parties
involved.

Engineer 1) FIDIC model contracts. Engineer as a

professional is vested with certain
authorities, powers and has specific
duties besides technical control, bill
certification etc.
Contractor
Owner

Presently the problems faced with FIDIC model are:

- FIDIC contract conditions are not truly followed. Most of the clauses are over
ridden with conditions of particular application or special conditions. Again such
FIDIC models or adopted FIDIC models violate basic philosophy converting them one
sided.

- Not only the true spirit of FIDIC model is lost, but with the cut & paste methods
there is poor drafting resulting in ambiguities, discrepancies creating disputes
during execution stage.

- The Engineers independence, authority is curtailed.

2) Owner contractor model of contracts.

In Government Departments, Organized Private Sector

Departments where the owner has technical staff qualified.
There will be well defined rules , procedures and delegated
Owner Contractor authority in the hierarchical set up.

The owner exercises over all control himself and administers the contract.
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5.0 Important contract conditions:

Normally at field level the staff have a tendency to refer only the BOQ part for rates for
preparation of bills. At operation level for day to day of activities and progress this may
be alright and the contractual issues are dealt at higher levels.

But at senior levels and for a Project Manager , to be successful in execution , apart from
project management the skills of contract administration is imperative at all levels.
A thorough study of the entire contract documents is highly recommenced .

Following are some of the important sections / clauses in construction contracts .

1. Definition of terms : Generally the first few pages will define the terms and
terminology, parties & their roles. This is important and gives a legal meaning of
terms used like variation, deviation, approval etc.

2. Instructions to Bidders (ITB): The instructions to bidders present the information on

scope of work, qualification criterion, schedules and information to be furnished
and Security, EMD, Performance Guarantee details etc. Again this gives important
information including taxation and such data and particulars relying on which the
bidder is expected to quote his prices.

3. Conditions of contract and special conditions :

These are the general conditions of contract stipulating various terms for execution
of work through operation of contract.

Some important conditions in general pertain to the following:

Terms of payment, Interim payment certifications or R.A. Bill submissions

1. Financial aspects: Mode of recoveries for retention money, mobilization

advances terms, performance guarantee terms, secured advance on materials
etc.
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2. Time extension: Normally time is regarded as the essence of any contract. The
terms and events for granting extension of time are specified.

3. Liquidated damages: Normally stipulated as a fraction of % of contractors

value per week of delay subjected to a maximum limit.

4. Price variation: It is specifically mentioned whether it is a fixed price contract

or price variation (price escalation) provision exists. Generally the components
of work qualifying for variation, percentage or factors and the applicable
formulae based on consumer price indices and labour, POL indices are given.

5. Deviation limit: A deviation limit is normally stipulated + or - % of individual

quantities of items up to which the rates shall be valid.

Again there can be over all deviation limit specified on the contract value as a
whole.

6. Variations/ extra, substituted items: Terms and the rate deviation procedures,
notification of occurance of such events by contractor, submission of rate
analysis mentioned.

7. Force majure events, hinderance events are specified.

8. Dispute resolution procedures: The discrete methods steps and procedures for
dispute resolution are stated in this clause.

Normally arbitration as per Indian Arbitration and Conciliation Act, 1996

specified.

As already stated the contract need not be in writing but as per law, the
arbitration agreement, if exists, it shall be in writing. This also may specify the
terms, procedure and appointment of arbitrators.

The wording of dispute resolution, the series of discrete steps are important
and one is expected to be cautious on this.
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Again in some cases there can be a finality clause (barring arbitration for
certain clauses treating them excepted matters).

10. Statutory provisions: Certain provisions on applicable taxes, mandatory insurance

provisions specified.

Incorporation of statutory laws and some conditions on wages, labour & regulation,
working conditions stipulated.

Apart from these conditions of contract as a standard set of conditions in an

organization, there can be special conditions of contract which override the GCC
and have higher precedence.

Generally Central, State, Government Construction Departments, Public Sector

Undertakings and some organized Private Departments do follow their own
standard set of contract conditions which normally followed for works contracted
by them.

Others follow such conditions of contract on a case to case basis. It is a normal

practice that the consultant / architect or engineer will draft a set of conditions
by following a FIDIC model or FIDIC with overriding conditions of particular
application.

There are a number of instances that such cut, paste method in conditions and lack
of standardization has resulted in poor drafting of contract conditions leaving scope
for errors, ambiguities.
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6.0 Contractual obligations:

During the execution phase, the contract administration is crucial for success of
implementation of project. The parties are expected to fulfill their respective contractual
obligations fully and fairly.

Thus a contract as a set of reciprocal promises, creates and defines the duties obligations
between the parties. Also it generates contractual rights. On performing the duty as on
obligation, the party will acquire a consequential right. For example the contractor has
executed the portion of work as per the terms after which be acquired a right to claim the
payment.

For performance of the work normally the owner or Employer has following obligations:
a) handing over of site
b) Supply the agreed materials in time
c) Issue of drawings
d) Decisions and approvals
e) Delver the agreed facilities
f) Timely payments as per agreed terms

The performance of the other party is obviously crippled for want of fulfillment of these
obligations.

It is imperative to go through the terms and conditions of contract carefully.

In general in construction contracts terms and time frame for releasing the payment are
specified which is the right of the contractor .

Further in contracts there will be certain terms and conditions specified for certain action
from contractors side in the event of occurrence of some events like delay, deviation,
variations etc.
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As an example the terms may be like, as follows:

1. In case of hindrance - to intimate the project-in-charge with details within seven days.

2. On occurrence of variation (extra) items beyond the scope, to intimate with in 15 days
along with rate analysis

1. Immediate intimation in case of deviation in BOQ quantities.

All these are nothing but contractual obligations to be performed, as duties, in legal
terms.

Neverthless if the intimation is not given in specified time, it is not that the claim or right
on deviation or extra item is lost. This is because the general limitation applicable by law
cant be shortened or extended by mutual agreements.

The above time limitation may be construed as a check ensured by the client. But what is
the answer for the question - what prevented the contractor in giving such intimation, in
time, which was his duty.

So it would be appropriate to follow such conditions which are obligations. Just a two line
communication may be adequate to prove that, we have discharged our duty.

It is advisable to go through the terms of the contract in each case , thoroughly.

Such good practices if followed as matter of routine will definitely yield good results.
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7.0 Correspondence:

Correspondence is an essential part of contract administration.

Going by the literal meaning of the word (dictionary) correspond means communicate by
exchange of letters.

For efficient site management the requirement of good correspondence is inevitable and
doesnt need a special emphasis. From the perspective of execution of work at site
through a contract, the correspondence can be categorized in to three types based on the
purpose. The three types of correspondence are General, Obligatory and Necessary.

General Correspondence:

The correspondence that is to inform (informative) or appraise or to communicate and

keep on record something, is general correspondence. This can be with reference to
progress, regular events at site or at times it can be directive or instructive to do or not to
do certain things.

Obligatory Correspondence:

This refers to the letters and communication exchanged as a binding or obligatory in

nature. Suppose one of the party to the contract is supposed to give a notice with in a
period specified on occurrence of a particular event, then such correspondence is
obligatory i.e., in fulfilment of a contract condition. The letter of Intent, communication
on work acceptance, issue of notices like commencement notice, completion notice,
termination notice etc., fall under this category.

Necessary Correspondence:

This is categorized as one which one party would like to keep on record with an intention
for any future reference. The party at a later date can use such communications and
correspondence as a matter of record that the other party was already intimated and has
full knowledge of the events.
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Nevertheless any correspondence whatever may be the purpose basically reduces to

writing of letters in official form and sense. We do all agree that letter writing is an art
and skill both, which partly can be inherent and the rest by practice. Again it is a myth
that for making a good correspondence one should be highly proficient in English language.
Even with simple language good correspondence can be made effectively .

Following are few tips for making good correspondence:

1) The subject mentioned for the correspondence should be brief and specific,
pointing to the gist. Mentioning too many references is not a good practice. Some
persons while replying have a habit of referring what all they had written
previously.

2) The body of the letter is important which reflects a particular style. This should
carry the decency and decorum of official correspondence.

3) Unnecessarily very lengthy and narrative style is not desirable.

4) Correspondence should be brief, specific and highlighting only what one intends
to convey.

5) Unnecessary references, such examples, usages of idioms & phrases sarcastic in

nature are highly undesirable. Even while replying to a derogatory letter received,
one is expected to be cautious in this regard.

6) Naturally the language and style one intends to employ in writing is influenced
by the mother tongue and the expression in writing is influenced by spoken
language. Some care is needed in this aspect.

7) It is better to go through the draft made twice or thrice for a review in initial
stages.

8) In the contract the roles of Engineer, Engineer-in-Charge, Project Manager etc.,

will be clearly defined. Based on this the correspondence has to be addressed to
the particular person regarding the issues like progress reporting, decisions etc.

9) Unnecessarily the dispute resolution clause should not be quoted in general

correspondence.
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8 .0 Maintenance of records:

Keeping something on the record through communication, recording & preserving the
documents etc. all are vital as a part of Contract administration.

Generally time is regarded as an essence of any contract. The onus of performance of

the job assigned within the stipulated time lies with the contractor which is one of his
prime contractual obligation. If there are reasons, causes by which performance got
effected or likely to get affected, then the contractor should keep a record of such
hindrances and shall timely intimate the employer. Suitable communication / application
shall be moved well in time for time extension. Generally this aspect is taken casually
which may have serious implications at later stages. As a matter of routine and as a good
practice the Project Manager is expected to apply for time extension well with in time,
with all records of hindrances and justifications.

Proper record of hindrances with evidence is a must.

8.1 Work hindrance during rains:

Rainy season has a special significance to the site personnel. On rainy days, due to
continuous downpour the work schedules are totally disturbed, labour displaced from work
places and work output is drastically reduced with progress and targets severely affected.

Yet a client may not like to understand this and may say:-

- No time extension because in stipulated time, effect of rainy season already

taken care of
- No hindrance can be recorded as rain is not continuous but only intermittent
- Contractor could have taken enough care to show desired progress even in
rainy season
- Delay will not be acceptable on account of rains

It is a well known fact that the progress will be affected and hampered in rainy season.
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Continuous rains do inundate the site making it difficult to work. Pits, low lying areas will
be filled up and water needs to be drained off each time. There will be slush, mud all
around. Movement of trucks, mixers will be affected due to wet roads and slippery tyre
conditions.

Even though the rain is intermittent, labour once disturbed from work and got displaced
on a particular day cant be easily redeployed effectively. Working conditions for labour
are difficult to show much output during rains due to various factors. Construction being a
labour intensive activity cant follow the logic of factory type of working with switching
off/on of machines to get the desired output.

8.2 Dewatering:

Again the construction activity may require dewatering operations. Ordinarily the
water seepage through underground (sub soil strata) during excavation is to be carried out
by contractor at his own cost as part of a technical condition. But what if the dewatering
operations necessitated due to rains or flooding of site and not by sub soil percolation.
This is obviously not envisaged initially while bidding. One is expected to keep a record of
such operations carried out like no. of pumps, days of dewatering through log books.
Proper timely communications with Employer are necessary.

8.3 Idle Resources:

Further there can be a situation of resources deployed for the work being idle or
under utilized for significant periods. Idle or under utilization (Partly idle) of resources
(man power, machinery) deployed for the work are the results of non fulfillment of
contractual obligations of other party like availability of work fronts, drawings, decisions,
required material supply in time.

Based on the work program and mutually accepted schedule, the contractor deploys his
men, machinery for the work. He incurs the costs towards man power like salaries,
establishment of site, office & overhead costs for maintenance of site establishment
besides mobiles, phone, fax, computer, printing, stationery, transportation etc. Normally
these will be expressed as a percentage of turnovers likely to be achieved as a
recoverable cost from turn over.
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Further the machinery, equipment deployed for the work is intended to give a planned out
put of work so as to recover the costs. So if the performance in the work is affected there
will be loss in anticipated turnover. This loss in turnover results in under utilization of
recovery of costs incurred.

1. These are viewed as damages suffered by one party due to the default of other
party. Damages are quantified as Losses suffered which attract compensation.
Obviously losses to be compensated signify that one need to prove the actual
losses incurred.

2. Losses have to be claimed with the proofs and evidence on deployment of

machinery and men with knowledge of other party by suitable communication and
record keeping.

a) Pursue the contract conditions for remedy in case of delay events, owners risk
events and contractors risk events.
b) List of men & machinery that are actually deployed at site to be communicated
to employer by progress reports or periodic correspondence. Relevant details of
machinery like type, make, description, and numbers etc., to be invariably
listed and mentioned. Regarding the idle manpower the particulars of staff
deployed at site i.e. Names, designation, numbers etc. to be indicated.
c) Record keeping & evidence
d) Periodic correspondence with employer.

Calculation of actual losses arising due to idling of resources is depicted in next

subsequent sections.
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9 .0 Construction Claims:

9.1 Introduction:

Claims in construction contracts are inevitable. To tackle the problem of the claims
effectively it is necessary for both sides to have a better understanding of the basis and
principles of contract and therefore of the rights and obligations of the two parties. It is
necessary for professional representatives of both sides to have an understanding of
business side of industry so as to appreciate the circumstances in which the contractor
conducts the risks in which he can properly and contractually be expected to undertake
and the financial consequences if things go wrong. If things go wrong by reason of any
default on the part of contractor, it must remain his concern; however, if the default lies
with the employer or his management team, then the employer must face the financial
consequences and settle the claims without any loss of time to avoid any adverse effect on
progress of work.

It must also be born in mind that the whole question of claim is very complicated, since
the preparation of claim is not only difficult but lot of efforts are needed to extrapolate
the relevant data, fundamental details, figure, data and, other evidence together with the
establishment of sound basis so as to demonstrate fully the validity of claim argument.

Preparation and presentation of claims is a systematic process. Since the burden of proof
lies with the party raising claims, the supporting evidence together with the facts in issue
and basis of claims is to be presented. The substantiation of claim is done through site
records, correspondence, site diaries, progress schedules, minutes of meetings etc. The
contractor therefore needs an expert who can assist him in this area.

9.2 Different Types of Claims

i. Contractual Claims
ii. Extra Contractual Claims
iii. Quantum Meruit Claims
iv. Ex-gratia Claims
v. Counter Claims
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Contractual Claims

These are the claims, which arise out of the express provision of the particular
contract, i.e., for extra cost, expense and direct loss specifically provided as a remedy in
the contract for breach of contract on the part of the party concerned.

Extra Contractual Claims

These claims are also known as common law claims. These claims are for damages
for breach of contract at common law.

Quantum Merit Claims

Provide remedy for a person who has carried out work under the instruction of the
owner but no price has been agreed or where a new one has replaced original contract and
payment is claimed for work done under the substituted contract.

Ex-Gratia Claims

Ex-gratia claim is one where no legal remedy is available to the contractor but
arise out of hardship. On the ground of equity or favour the authority concerned may in
certain circumstances consider that hardship calls for mercy or moral liability. These
claims are also called sympathy claims. Wherever such claims are to be given it will be
better if these are given during the currency of the contract so that the money paid helps
in improving the progress of the work.

Counter Claims

These are the claims raised by the opposite party to counter the claims of the claimant.

9.3 Potential Causes of Claims:

i. Delays in handing over of site, work fronts
ii. Variation in data/information supplied and that actually encountered during
execution
iii. Late supply of drawings, decisions, approvals
iv. Disruption/disturbance caused due to untimely or unjustified instructions
v. Employers defaults affecting performance like delayed payments, illegal
recoveries etc.
vi. Deviations , variations beyond agreement provisions , change in scope
viii. Non approval of justified rates for Variations , extra scope works
ix . Violation of Contract conditions , stipulated and agreed provisions
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10.0 Dispute Resolution:

10.1 General:

The dispute resolution steps and the systematic procedure to be initiated will be
normally stipulated in a particular related clause in the agreement. For example clause 67
of contract conditions of FIDIC specifies the dispute resolution procedure.

It is recommended to thoroughly go through the dispute resolution clause and procedure

laid in the agreements. The dispute resolution clause shall not be quoted in normal
correspondence unless the disputes are to be dealt for resolution under such clause. The
entire process right from claiming some thing, establishment of dispute, notice and
invocation of dispute resolution should follow systematic steps as stipulated in agreement
and have to be done in a legal manner.

The readers are suggested to give a thought on the legal meanings and differentiation
between a claim and dispute. For example you go on claiming something and the other
party keeps silent does any dispute existing at this stage?
Say you claim something, other party denies then one can call it a dispute. Again one
party serves a notice to other party to settle something with in a time frame, other wise it
will be deemed as dispute. In certain cases the Dispute resolution clause itself specifies
the steps or procedure how to establish a dispute. Thus establishment
Of Dispute is important before invoking Dispute resolution Clause.

Normally in Contracts invoking Arbitration cant be direct and one or few of following
mentioned ADR (Alternate Dispute Resolution) methods should have been generally
stipulated as a precursor procedure before Arbitration.

10.2 Alternate Dispute Resolution (ADR) :

These are some of the Alternative Dispute Resolution (ADR) methods.

1) Engineers decision has to be sought by making a reference to the dispute (FIDIC

model contracts has this provision)
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2) Negotiation Between authorized representatives of the parties or Managements

3) Mediation (The disputes are referred to a mediator as in village panchayats)

4) Conciliation (The conciliator assists the parties and facilitates in arriving an agreed
settlement)

5) Disputes Resolution Board (DRB) : Disputes are reviewed by a Board of technically

competent persons constituted by parties and recommendations made by the Board
on Disputes referred to them .

10.3 Dispute Resolution Board (DRB) :

The Board normally consists of 3 members (one will act as chairman) constituted by
parties consisting of technical professionals well acquainted and experienced with the
subject works. The Board is expected to make site visits and offer technical guidance. Also
the Disputes are referred to the Board which will review the Disputes and give the
recommendations on Disputes. The judgments of the board are in the form of opinions,
technical judgments and recommendatory in nature. Such recommendations have no legal
enforcements as in case of Arbitration awards.

The parties are expected to follow the recommendations made by the Board on
Disputes and attempt to settle the same. The recommendations of DRB are open for
review in the Arbitration.

10.4 Arbitration:

Arbitration if provided in the agreement shall be through a written agreement as per

prevailing law, as already dealt.

It is recommended to study the bear act provisions of Indian Arbitration and Conciliation
Act 1996 applicable for Domestic Arbitration.

Arbitration may be conducted by a sole arbitrator or by an Arbitral Tribunal.

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Normally the procedure of appointment of Arbitrators are stated in the concerned clause
of Dispute resolution or otherwise the rules and procedures can be as mutually agreed by
parties.

Different departments, organizations follow and adopt their own standard procedure of
rules and regulations for conducting Arbitration for construction contracts. To reduce the
time, to speed up the process and to standardize the procedure across the industry,
Institutional Arbitration is gaining more popularity in India for commercial contracts. The
entire Arbitration process, procedure of conducting Arbitration, time frames, rules &
regulations are governed by the Institute which has governing rules & procedures. Indian
Council of Arbitration (ICA), Construction Industry Development Council (CIDC) in
association with SIAC (Singapore International Arbitration Centre) are the prominent
bodies providing institutional Arbitration mechanism in India .
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11.0 Idling of Resources and Prolongation of work:

Owner caused delays or delays brought about by owner-assumed issues are common

in construction projects. In the previous sections how to keep the records for such delays

was dealt in detail. Due to such delays the performance will be affected resulting in

prolongation work. The budgeted cash flows / monthly turnover will be reduced wherein

the machinery, equipments deployed for the work are under utilized in a way (loss of

production). Normally the contractor mobilizes and deploys the required resources based

on the quantum of work out put to be given and recovers such costs on manpower,

machinery, equipments from the turnover.

Besides other overhead costs such as office establishment, transport,

communication, travel etc., other such costs cannot be fully recovered with reduced

turnover .This results in losses since the incurred costs are not fully recovered. Again the

reduced turnover results in a loss of anticipated profit which the contractor expects to

derive from turnover. Nevertheless in the prolonged or extended period, the contractor is

constrained to block his resources in execution of same work otherwise he would have

deployed such resources in other works. This is termed as loss of opportunity .

Once the delay is established, the next question is the justified element of cost

compensation in consequence of such delay. Say how much will be the overhead costs as

losses and what would be the element of profit to work out the loss. Some standard data

books and Govt. departments adopt a fixed percentage say 10% as contractors profit and

take 10 to 25% as overhead costs, for the purpose of analyzing the standard costs or for

working rate analysis.

There are numerous theories, principles and formulae for estimating and working out

overhead costs. Among these, Hudsons formulae, Emdens formula are most popular and

used universally. Courts have also recognized the principles upon which such formulae are

based.
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For ready reference the brief description, methodology of such formula given below.

However the readers are advised to refer the text books like Law relating to Building

and Engineering Contracts by Sri Gajaria and search Internet for the philosophy of such

formulae.

The formula are based on the principle that

- A contractor is entitled to compensation for unabsorbed overhead costs resulting from

owner caused delay, if they meet certain criterion.
- There is no exact accounting method for calculation of such unabsorbed costs.
- A fair, realistic cost estimating formula is necessary to determine the compensation,
owed.

Hudson Formula:

This formula was deliberated widely in courts in U.K. and later exported to Canada. Off

site overheads are usually known in the industry as Head office overheads (HOOH). It is

convenient to deal with these together with profits, because it is the practice most

contractors do follow by making their best estimate of the project by loading a single

percentage (profit & O.H) as factor on the prime cost worked out.

The percentage used in pricing for such overheads and profit obviously varies from

contractor to contractor which is a closely guarded secret. On analyzing the evidence

presented in courts by way of balance sheets, profit & loss accounts of companies, the

courts have also recognized the principle of such factoring or fixed percentages.

The Hudsons formula derives its daily HOOH rate on the basis of the as-bid calculations

and assumes that the bid rate shall hold constant through out life of project.
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O.H. / Profit Percentage Original contract sum

________________ x _____________________

100 Original contract period (weeks)

x Period of owner caused delay (weeks)

= Total O.H . Cost owed

That is allocable overhead per day/per week x period of owner caused delay

=Total O.H cost owed.

Example:
Contract amount : Rs.120 crores
Stipulated period : One year (52 weeks)
Owner caused delay : 12 weeks
HOOH (i/c Profit) : 25% (15+10)

As per formulae

Allocable overhead per week = 25/100 x 12000 lakhs / 52 = Rs.57.7 Lakhs

Total cost owed = 57.7x12 = Rs.692.3 Lakhs
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12. Loss of Productivity :

Normally in large construction projects where more machinery and equipments are

deployed and their costs, component wise in overheads is significant then loss in

productivity is worked out based on the loss in turnover on proportionate basis. This not

only appears realistic but close to actual unabsorbed costs.

For an example in above case, for the project there may be certain requirement of

machinery and manpower either stated in bid or submitted along with the bid proposal.

Further there may be a works program or estimated cash flows month wise for the project

which is the basis for projected or budgeted turnover each month.

Nevertheless in absence of such anticipated or budgeted monthly turnover one can easily

work out the average monthly turnover for above example as 120/12 =Rs. 10 Crores.

By achieving this average monthly turnover, the contractor anticipates to recover his costs

incurred on various overheads. But the actual turnover achieved due to owner caused

hindrances is say for example is Rs. 6crores per month.

This shows that only 60% of utilization of resources with 40% loss in productivity. Hence

unabsorbed costs are 40% of costs incurred on actual basis for manpower and machinery.

12.1. Manpower Costs: Can be worked out as per actual deployment and payments on

CTC basis for the supervisory, technical and site staff.

12.2 Machinery Costs: Machinery costs can be worked out for the equipments deployed.

Theoretically for the owned equipments the costs are depreciation + interest costs and for

hired machinery, the actual hiring costs.

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For ready reference a tabular format shown for calculations.

S. Description M Yr. Of Nos Capital Hire Interest Depreciation Total

of Machinery a purchase . cost charges cost

No.
k per day Int+Dep

e .

For construction equipments normally 7 to 10 years of life assumed.

1. Straight line depreciation method (linear) normally assumed with 10% residual
value.
2. Commercial rate of interest taken
3. For own equipments if data is not available, market hiring charges can be adopted.

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SUGGESTED REFERENCES FOR READING:

1. Law Relating to Building and Engineering Contracts by Gajaria

2. Law of Contracts Dr. Avtar Singh

3. Study Material of NICMAR on Construction Contracts and Contracting

4. Indian Contract Act, 1872

5. Indian Arbitration and Conciliation Act, 1996