A New Form of Building Contract

Progress, Volume XVI, Issue 6, 1 February 1921, Page 127

A New Form of Building Contract

By the courtesy of the Hon. C. J. Parr, Minister of Education, a representative of Progress was permitted to interview Mr. John T. Mair, A.R.1.8.A., architect to the Education Department, with reference to a new form of building contract described by him in a paper read before the Conference of Education Boards held in Wellington on January 25th, and to publish the following extract, which is of special interest to the architects and builders of New Zealand;—

“The necessity for more schools and the difficulty in securing their erection, even at the high prices ruling, are too well known to you to require stressing here.

“It is my purpose to place before you the alternative methods whereby Education Boards may secure the erection of schools with reasonable safeguards to the Department against exploitation by the builders.

“Fluctuating prices of materials, uncertainty of supply and delivery, and the unsettled labour conditions, have introduced such an element of gambling that throughout the world builders have declined to enter into definite lump sura contracts, except at exorbitant prices.

“Methods have been evolved whereby the builder is, in varying degree, relieved of the gambling element. Apart from the cases where the owner supplied the materials, or bulk of the materials, and let the remainder and labour by contract, the following methods have been adopted:—

(1) A clause was inserted in ordinary contract conditions allowing for adjustment for any increases in labour or materials during the currency of the contract. (2) Day labour on a percentage basis. (3) Day labour with an agreed lump sum as the builder’s total profit. (4) Actual cost plus an agreed lump sum, or fee, subject to a penalty and bonus clause contract.

Under method (i) a statement of the rates of labour and material, upon which the contractor has based his tender, forms part of the contract, and the owner assumes responsibility for all increases on these figures.

Under method (2) the owner assumes full responsibility for the total cost of all labour and material, and in addition pays a percentage on cost to the builder.

“Both of these methods have been universally condemned, as they provide no near approximation of cost before commencement, and afford no incentive to a builder to expend time and energy in judicious buying or in the engagement and control of labour.

An Improvement on Old Methods

In method (3) the builder submits an estimate of actual cost and enters into a contract to carry out the work by day labour for a fixed additional fee (usually 10 per cent, on the estimate) which is the total amount payable to him as profit, whether the actual cost exceeds or falls below the estimate. This method eliminates most of the objections to method (2), as it offers no incentive to the builder to keep the cost up, and does not penalise him for effecting a saving. In 1915 I adopted this method and found it quite satisfactory; the only objection being that should the estimate be considerably exceeded and the builder find himself working for nothing, he is apt to lose interest in the work at the end. In every case the quality of materials and workmanship was more uniform than contract work done simultaneously.

Method (4.), generally referred to as the “Cost plus Fee with penalty and bonus clause contract,” was developed out of method (3) by American architects and builders in 1919, and since then has been almost exclusively adopted in America and has been copied in other countries.

“Under this method the selected builder submits an estimate of ‘actual cost’ and states the amount of the lump sum or ‘fee’ in addition, for which he is prepared to carry out the work. These figures, if satisfactory to the owner, form the basis of a contract wherein it is agreed that the ‘fee’ payable to the builder shall be reduced if the estimate be exceeded or increased should he effect a saving on the estimate.

“The amount of the ‘fee’ is usually found to be from 7 per cent, to 10 per cent, on the estimate—a common practice with American builders being to make it 10 per cent, on the estimated cost of labour and 6 per cent, on materials.

“The ratio which the penalty or bonus bears to the excess or reduction of cost, as compared with the estimate, is a matter for agreement between the parties, but usually the local Builders’ Association and Architects’ Association have come to an agreement on this point. In some cases the bonus is greater than the penalty; in others vice versa , and builders have in some instances contracted to bear one-half the amount of any excess over estimate.

“My information is that in America the bulk of the work is carried out on a basis of reduction of, or addition to the fee, by an amount which is the same percentage of the fee that the amount of excess or saving is of the estimated cost. The following example on that basis will clearly exemplify the working of the principle:—Assume a building estimated to cost for actual labour and material £IO,OOO and a fee of £I,OOO asked by the builder—total estimated cost £ll,OO0 —and considered

reasonable by the architect and the work carried out.

“If the job actually costs £12,500 (an excess of 25 per cent, over estimate) the fee will be reduced by 25 per cent., or will amount to only £750 —a penalty of £250 on the builder for inaccuracy—making the actual total cost £13,250. Inversely, if the finished job cost only £9,000 (a saving of 10 per cent.) the contractor’s fee is increased by 10 per cent, and he would therefore receive £I,OOO, making the actual total cost £IO,IOO.

“This method also affords a means of securing competitive estimates by several builders. In this case the ‘tender’ is an estimate of actual cost and statement of the amount of the additional fee for which the tenderer is prepared to carry out the work under definite contract conditions. This feature of competition has not, however, the merit which at first sight appears.

“In this form of contract the personal equation of the ability and character of the builder is of much more importance than in a straight-out contract.

“An architect may know from experience that the builder —the aggregate of whose estimate and fee is the lowest—has not the ability or organisation to enable him to carry out the work without such an increase on his estimate as would ultimately bring the price higher than an initially higher estimate. “Care requires to be taken in letting such a contract to a construction company doing a large volume of work to ascertain that the actual man to be in charge of the work is competent, as he is an employee only, with practically no monetary interest in the resultant cost.

“Indeed, a great advantage of this form of contract is that men of capital are not necessary as contractors. The terms of payment can be so arranged that all financing over and above the amount of the fee is done by the owner—in which case the field of selection is very much widened. “The advantage of several separate estimates obtained would appear to be great, but in reality is not so, for the following reasons:—(l) Because of the danger of collusion to estimate high; (2) the tenders may all, without collusion, be so high that the chance of being exceeded hardly exists —in which case the contractor has a double source of profit; (3) in the end comparison with the architect’s estimate is the determining factor, not comparison of tenders. It is instructive to examine the result of a wilfully high estimate undetected by the architect. For this purpose we will assume a contract let on an estimate of £12,000 with a fee of £1,200 —total estimated cost £13,200 —and the actual cost to be only £9,600, a saving, chiefly fictitious, of 20 per cent.

“The contractor will, therefore, receive the fee of £1,200 plus 20 per cent., or a total of £1,440, thus bringing the actual total cost out at £9,600 plus £1,440 = 1,040, which is £2,160 less than the anticipated cost of 3,200 for which finances were

arranged—a position exactly the reverse of that created by dishonesty in any other form of building contract.

“In addition to the basic terms of contract (the amount of estimate and the fee) other conditions are necessary to protect the owner’s interests and obviate any causes of friction between the parties. Such conditions should provide:—

(1) That the work must be performed in accordance with the plans and specifications and under the supervision of and to the satisfaction of the architect, who shall have power to vary the contract in this respect.

(2) That the fee payable to the contractor shall cover the wages of any superintendent where the contractor does not superintend personally.

(3) That the contractor shall make good at his own expense any defects appearing within a stipulated period of maintenance.

(4) That any temporary sheds and all tools and plant necessary (other than scaffolding and boxing) shall be provided by the contractor for the fee, but that he shall be allowed an amount, fixed by the architect, to cover depreciation, which shall be charged against the cost of the work. (NOTE. —Any office required for a clerk of works or overseer must be mentioned in the specification.)

(5) “Cost” of material must be defined and a definite statement made of what discounts, if any, are to be chargeable to the owner in cost.

(6) The owner must have power to discharge the contractor at any time on payment of all cost to date, and a proportion of the fee in ratio to the value of completed work to the estimated total cost.

(7) The ultimate control of the purchase of material must be t in the hands of the owner. The contractor must agree to buy in the best available market all material required for the work, subject to the quality and price being approved by the architect.

The owner to have power to supply any material where he can purchase at a price below the best quotation obtainable by the contractor. (Note. —Any saving effected operates to increase the contractor’s chance of earning a bonus.)

(8) The contractor shall be responsible for the en g a g eme nt of all labour and payment of wages, and shall employ none but the most competent tradesmen available.

He shall not pay less than award rates of wages, but shall require the consent of the architect to any increases.

The architect to have the usual power of objection to the employment of any man.

(9) The architect’s right of entry on the works should be stated, and the architect or owner should have power at any time to examine all books and documents in connection with the work. The contractor to submit all invoices, receipts and pay-sheets to the architect before payments are made.

(10) The contractor shall not have power to sublet any portion of the work without the consent of the architect as to price and individual. The owner to be at liberty to let sub-contracts where he can obtain prices lower than those submitted through the contractor.

(11) The contractor to insure all workmen and to indemnify the owner against accident to himself or the workmen. Also to insure the building in their joint names. All premiums to be a charge on the works.

(12) Should state the periods and conditions of payment in conformity with the Liens Act. The fee being regarded, during the currency of the contract, as a fidelity bond. (13) Should provide for payment of additional fee if additional work be carried out.

Such increase should be the same percentage of the cost of the extra works as the original fee is of the actual cost of original contract.

Should work be omitted the fee to be reduced by an amount which is the same percentage of its estimated value as the fee is of the original estimate.

(14) Should provide that the fee snail be forfeited in the event of the contractor abandoning the work.

(15). It should be provided that in the event of any dispute between the owner and the contractor the architect’s decision shall be final.

“This form of contract, when under the control of a thoroughly practical architect, is fair and reasonable to all parties. It fixes the cost within a small percentage and allows the architect full control over any variation; provides ample incentive to economy by the builder, and promotes harmony instead of ill-feeling.

“In order that the owner may get the benefit of these, however, the architect or his organisation must keep constantly in touch with the work and be thoroughly conversant with all sources of supply and fluctuation in prices, so that he may keep a check on the contractor’s quotations and help instead of hinder expedition. Such being the case, the architect’s organisation to cope with the work requires to be considerably increased above the personnel necessary under old conditions.

“In America an additional 4 per cent, is charged by the architects to cover the salaries of the additional overseers required, and the public is satisfied that value is received for the money.”

Our representative raised the point that no provision was made to allow for any increases in labour or material, and Mr. Mair has very kindly supplied the following answer, and stressed other points worthy, of note:—

“With regard to the point raised, that materials and labour may rise during the currency of the contract and the builder should be reimbursed for this amount.

“Any condition allowing for this is expressly omitted from the contract for the following reasons:—

(1) It would necessarily require inequity to allow for reduction in the event of a fall

in prices as well.

(2) Such a condition would reduce the contract to practically a day labour job.

(3) The essence of the contract is to provide that both builder and owner have a mone-

tary interest in preventing, as far as they can, such increases.

(4) Only a small percentage of the increases, if they occur, becomes the builder’s responsibility, whereas any fall in prices operates towards earning him a bonus.

(5) The “fee” provides a means whereby the builder may provide a small amount to compensate for any increases he deems will

eventually occur.

“Those intimately concerned in building operations know that quite a lot of the inflation of prices of both materials and labour was due to the large amount of work being done under the old 10 per cent, method, in which the builder not only saved himself the trouble of trying to obtain materials outside any local ring, but gained an increased profit by such inflation. Many builders are shareholders in companies controlling production, and a dividend anticipated does not tend to secure their co-operation to keep prices down, unless there is a stronger incentive to buy at low rates.

“In order to fully understand the operation and equity of this form of contract with regard to fluctuations in material or labour, it is necessary to realise that the ‘fee,’ or lump sura (stated over and above the estimate of actual cost), is a composite amount consisting of four parts, viz.:—(1) Profit (or wages) required by the builder during the currency of the contract. (2) An amount, which his experience and the degree of his supervision of the work makes appear to him sufficient, to cover the cost of rectifying defects appearing during the maintenance period. (3) Part cost of sheds and plant if he deems a depreciation allowance insufficient. (4) A gambling item determined by his knowledge of and ability to correctly forecast the trend of the market.

“This gambling item need not be large, and the following example will show that it is not a serious item to the builder.

“Let us assume that £I,OOO of the increase of £2,500 on the estimate of £IO,OOO (in the example previously referred to) is due to increased prices of materials. It will then be apparent that the actual increase over estimate was £1,500, or only 15 per cent. A deduction from the agreed fee (£i,cu. 15 per cent, would lower it to £BS0 —or £IOO more than if the £I,OOO had been included. The builder therefore under this contract would only pay £IOO of the £1,006 increase in prices.

“Inversely: if we consider that £SOO of the saving of £I,OOO (referred to in the same example) is due to a drop in prices of material, the actual saving on estimate would only amount to £SOO, or 5 per cent. A bonus of 5 per cent, on the fee of £i,oou brings it up to £1,050, or £SO less than if the drop in prices of materials had been neglected.

“The builder would in this case get £SO of the £SOO saving to which he in no way contributed.

“When making up his original estimate the contractor can allow for any immediate rise in prices he knows to be inevitable, and therefore any loading of the fee would be a very small amount.

“Should a contractor have such an organisation that he is able to purchase or produce materials below current market rates, he has the same advantage over his competitors as he would have under any other form of tendering and, owing to the contract element, employers find that they can get more work out of the men than is possible under 10 per cent. work.

“A feature of this system of special interest (particularly to builders with small capital) is that under it the builder cannot lose any of his capital.

“His loss will be a reduction of his estimated earnings, to lose the whole of which the cost, including maintenance, would require to be double his estimate—a very remote possibility.

“The system lends itself to co-operative contracting by a group of working partners tendering in the name of one of them, as all but he may draw full award pay, which is charged with any other labour to the job and regularly paid by the owner according to previous agreement as to periods of payment.

“The present advantages of the system will be increased when conditions become stable, and I believe that, once the builders become accustomed to it and realise the benefits to all concerned, it will permanently supplant the old tender system.”