construction contract fundamentals · 2020-01-08 · about baker tilly >established in 1931...

Construction Contract Fundamentals

Baker Tilly refers to Baker Tilly Virchow Krause, LLP,an independently owned and managed member of Baker Tilly International. © 2010 Baker Tilly Virchow Krause, LLP

About Baker Tilly

> Established in 1931> 16th largest accounting and advisory firm in> 16th largest accounting and advisory firm in

the United States*According to Accounting Today’s 2011 list of “Top 100 Firms ”Top 100 Firms.

> More than 1,300 professionals> Baker Tilly Virchow Krause, LLP is the largest

U S B k Till I t ti l i d d tU.S. Baker Tilly International independent member firm

> Baker Tilly International is the eighth largest public accounting network with representation in more than 110 countries

> Convenient, seamless resource for worldwide

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needs

About Baker Tilly

From concept and f nding to controls andFrom concept and funding to controls and compliance, Baker Tilly has more than 250 dedicated construction and real estate industry professionals to assist with your facility development project through all stages of the development lifecycle.

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Introductions

Tony Ollmann Erik SchuchardtCCA, Director CPA, Manager608 240 2618 608 240 [email protected] [email protected]

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Overview

Today’s Topics: Professionals in Construction Activities Professionals in Construction Activities Construction Lifecycle Owner’s Responsibilities Contracting Methods Key Risks Contract Provisions Contract Provisions

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Polling Question #1

Why are you here today?

A. To enhance my knowledge of construction contracting

Why are you here today?B. Because my organization

has a major upcoming construction project

C. I am interested in learning more about how I can contribute to upcomingcontribute to upcoming construction projects at my organization

D C t ti t tD. Construction contracts are unique and I’m curious to learn more!

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Please respond using the polling section in the WebEx screen to the right.

Construction Lifecycle

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*Architect/Engineer (A/E)

Construction Project Management Team

Owner Owner’s Internal Audit or Other ComplianceOwner Representative Other Compliance

Representative

Office of General Counsel Architect Construction

Manager

Other Groups and St k h ldStakeholders.

Internal & External

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Polling Question #2

A. Very familiar; I could have a fast paced How familiar are you pconversation with my construction team

B Familiar I o ld benefit

How familiar are you with construction terminology?

B. Familiar; I would benefit from a brush up on key terms and risks

C. Unfamiliar with key terms and risks

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Key Terms

Competitive Bid

Negotiated

Master Services Agreement

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Key Terms

Contract Types:L S (Sti l t d S Fi d P i ) Lump Sum (Stipulated Sum or Fixed Price)

Guaranteed Maximum (GMAX or GMP) Unit Price Time & Material Cost Plus Fixed Fee or Cost Plus Percentage Fee

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Key Terms

Contracting Methods: Competitive Bid Negotiated Construction Management at Risk Construction Management at Risk Construction Management Not at Risk Prime Contracting Direct Contracting

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Key Terms

Project Delivery Methods:D i Bid B ild Design – Bid – Build

Design – Build Integrated Project Deliveryg j y

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Key Terms

Financial Terms:L b B d R t Labor Burden Rates

Overhead Rates General Conditions Procurement Burden and Mark-Up Overbilling

Aggressi e Billing Aggressive Billing Value Engineering

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Construction Lifecycle: Feasibility and DesignDesign

Key Risks of This Stage: Stakeholder identification Architect selection Delineation of needs and wants Delineation of needs and wants Conflicting pragmatic and political objectives Note: Architects and engineers are not

typically “bid” but are selected based upon their technical qualifications

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Polling Question #3

AWhich contract method

A. Lump Sum

B. Cost Plus

is most used with projects greater than $10M?

C. Unit Price

D. GMP/GMAX

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Construction Lifecycle: Feasibility and DesignDesign

Example:A tl t t d di l hA recently constructed medical research facility ($300M) delayed construction so the design team could collaborate with the mechanical electrical and plumbingmechanical, electrical and plumbing professionals. This resulted in: 10% reduction in overall construction costs

P j t d ti t 12% b l Projected operating costs 12% below budget

Optimum building workflowC it b i d t f th Community buy in and support for the building.

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Construction Lifecycle: Contractor Selection & Due DiligenceSelection & Due Diligence

Key Activities of This Stage: Establish technical qualifications (facility’s Establish technical qualifications (facility s

responsibility) Assemble bid package with specifications (facility’s

responsibility)responsibility) Request financial package

Credit reportCredit references Credit references

Audited or reviewed year end financials Current financials

W k i P (WIP) h d l Work in Process (WIP) schedule Backlog schedule List of recent layoffs

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Key Activities Continued:I di t f fi i l k Indicators of financial weakness

Significant changes in owner’s equity Weak cash position Repeated late payments to suppliers Outstanding and recent contractor’s liens Refusal to supply financial information, especially if it is the

t fi i l t t tcurrent financial statement Mitigation strategy: Request a performance bond. The bond

underwriter will also closely examine the financial strength of th t t b f d iti th j tthe contractor before underwriting the project.

Caution: Performance bonds don’t mitigate all of the risks! An owner will not be reimbursed for time delays, cost of rework, additional internal efforts, or cost of capital.

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Key Risks of This Stage:S l ti t t th t i lifi d d t h th Selecting a contractor that is unqualified or does not have the financial stability to deliver the project and support its warranty obligations

Example:A financially weak contractor may result in suppliers and subcontractors not getting paid The impact to the owner issubcontractors not getting paid. The impact to the owner is significant:

Liens against the building may prevent occupancy Construction delays until subcontractors and suppliers are paidConstruction delays until subcontractors and suppliers are paid Reluctance or refusal by professionals to work on the project Lost discounts and credits, even late payment penalties Impact to the owner’s credit ratingImpact to the owner s credit rating

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Construction Lifecycle: Contracting

Key Activities:D t i i t t th d Determining contract method

Negotiating contract terms, conditions, and provisions

Risks: Paying too much for the building Restricting the owner’s ability to control

financial risk Empowering the contractor to legally

take advantage of the owner

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Construction Lifecycle: Contracting –Determining Contract TypeDetermining Contract Type

Lump Sum: Usually less than $10 million Usually less than $10 million Facility is fully designed Designs are simple and often a duplicate of

another facility There are fewer unknowns that lead to

change orders

Benefits: Known financial commitment Less owner’s administrative burden Less risk of scope creep and budget overrun

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Guaranteed Maximum Price (GMP)U ll d l j t Usually used on larger projects

Project nature is complex with unknowns Often coupled with a concurrent design processp g p

Benefits: Establishes a not-to-exceed price Enables the owner to benefit from value added

engineering, price reductions, and well managed procurement

Enables the owner to select and contract with the contractor while still designing the facility

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GMP ContinuedDisadvantages: Requires a more complex contract that specifies as much as

possiblepossible Burdens the owner with more project management and

administration Project complexity leads to more opportunity for aggressive or Project complexity leads to more opportunity for aggressive or

abuse behavior Contractors like to believe that their budget is the entire

maximum pricemaximum price

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Cost Plus or Time and Material ContractingU ll f d i hi hl l d l j t Usually found in highly complex and very large projects or extremely small maintenance projects

Unable to determine or estimate the overall project cost Projects typically last many years Used on projects like nuclear power plants and refineries

AdvantagesAdvantages Enables an owner to segment a very large project into multiple

smaller projects Advances the construction timetable so that progress is made

on simple phases while engineering continues on more complex phases

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Unit Price Contracts:T i ll d i tilit tti t f i Typically used in a utility setting or type of service

Limited application, used on projects like underground piping and road construction

These contracts establish a rate price for each type of service to be delivered

The delivery quantities may or may not be knowny q y y Unit price for each segment of work includes all direct and

indirect construction costs

Advantages:Advantages: High degree of control over scope and pricing Change orders are easier to calculate g

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Construction Lifecycle: Contracting

Starting point:American Institute of Architect (AIA) Contracts

AIA written to favor the architect and contractor, not the owner and should only be considered a starting pointshould only be considered a starting point

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Construction Lifecycle: Contracting –Contract ProvisionsContract Provisions

Provisions that apply to all contracts:Ch d f i i i d Change order process for scoping, pricing, and approval

Process for handling owner allowances and credits Process and pricing for reduction in work scope Process for using and reporting contingency budget Progress reporting Progress reporting Business ethics and professional conduct Insurance, guarantee, and warranty requirements Right to audit clause

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Polling Question #4

AWhy are change orders

A. Scoping and approval occur quickly

B

inherently more risky than other construction events?

B. Minimal documentation

C. Little to no competitive pricing

D. All of the above

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Change order provisions should include th f ll ithe following: Definition of major and minor change order Authority for approving each type of change order Authority for approving each type of change order Authority for using contingency budget Change order documentation

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Change order documentation should i l dinclude: Who is performing the work Cost breakdown of materials and labor with quantities and Cost breakdown of materials and labor with quantities and

rates for each Contractor markup Clear description of the scope of work Clear description of the scope of work Clear description of why the change order is necessary

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Example$6 illi ti j t $6 million renovation project

Design change necessitated $750,000 of additional electrical work

Construction contract defined change order approval, contractor billing rates and markup on materials.

Subsequent change order review uncovered markup had been taken on materials and labor.

Contractor refunded the owner $46,000.

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Provisions that are most li bl t GMP d C tapplicable to GMP and Cost

Plus: General conditions fees and definition of what General conditions fees and definition of what

this covers Construction management fee and definition

of allowable and non-allowable constructionof allowable and non-allowable construction costs in the formula

Self-performed trade and craft costsT d ft d f i l t h d l Trade, craft, and professional rate schedules

Allowable pass through expenses

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Costs typically included in General C ditiConditions: Job site trailer and utilities Winter conditions Winter conditions Small tools charge Project manager and principal labor charges

Ad i i i d h d Administrative and overhead costs Layout yard and construction material storage Value engineeringg g Accounting and project reporting

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Costs that are not typically included in G l C diti d th O ’General Conditions and are the Owner’s responsibility: Insurance Insurance General foremen and supervisory costs Pickup trucks and transportation Construction material purchasing and transportation Computer and office equipment

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Provisions that are most li bl t GMP dapplicable to GMP and

Cost Plus: Established labor and overhead Established labor and overhead

burden rates Shared savings calculation

S lf f d k Self-performed work Bidding Pricing Reporting

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Labor Burden:L b b d i th i t l t l t tLabor burden is the incremental cost employers cost to carry an employee on the crew. Typical labor burden costs are: Employee benefits Employers social security Workman’s compensation insurance Health and safety Health and safety Federal and state unemployment tax Union assessments (pension, training, etc)

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Labor Burden should not include:C t t k fit i Contractor markup or profit margin

Overhead allowance Vehicle allowance Tool allowance Union dues

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Labor Burden risks:O h i f ll bl b d t Overcharging for allowable burden costs

Charging for non-allowable costs Double charging for costs also covered by general conditionsg g y g Double charging for costs that are specific pass through

expenses

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Shared Savings CalculationThi i i ti t ll d b t thThis is an incentive program mutually agreed upon between the owner and contractor to share in savings that arise from:

Value engineering Aggressive purchasing strategies Contractor’s supplier relationships Contractor s supplier relationships

Shared savings risk: Materials that are commodity priced should b l d d f th h d i l l tibe excluded from the shared savings calculation.

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Self-Performed WorkT d d ft t ti th t i f d b th iTrade and craft construction that is performed by the prime contractor. Typical self-performed trades include: site preparation, concrete footings, floors and walls, wall framing, drywall finish, trim and finishtrim and finish.

Self-performed work should be competitively priced with a separate pricing and scoping document explicitly defining scope, rates, materials and pricing method.

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Construction Lifecycle: Bidding

Key Risks:D ti d t t f Donations and contractor preference

Unethical bidding practices Kickbacks Courtesy bids and not competitive bids

Example:The prime contractor is also a concrete and masonry contractor and intends to bid on this phase of work. The other subcontractors in the market don’t believe that they will have a legitimate chance to win the work and don’t submit their “best” price for the work. The prime’s bid is lowest and they are awarded the concrete work, even though this may not have been the lowest price

hi blachievable.

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Preconstruction Planning and Due DiligenceDiligence

Action Items:E t bli h t ti l d bj ti Establish contracting goals and objectives

Establish development team’s roles and responsibilities

Determine subcontracting methodology Develop contractor qualification criteria Establish bidding process Establish bidding process

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Preconstruction Planning and Due DiligenceDiligence

Action Items:D l bid d it i Develop bid award criteria

Develop owner communication requirements Develop project performance reporting requirementsp p j p p g q Develop project cost and financial reporting requirements Develop owner’s right to audit requirements

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Additional Contract Provisions

Project performance reportingE d l ti Earned value reporting

Cash requirements forecasts Construction schedule Budgeted costs to actual Estimate to complete forecast

Reporting requirements should include: Delivery deadlines Content Format

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Pay Application (Invoice) DocumentationE h th th li ti h ld b i d bEach month the pay application should be accompanied by: Material invoices and receiving tickets Time sheets for self-performed workp Subcontractor invoices Equipment logs for contractor provided equipment

Lien ai ers Lien waivers Equipment rental invoices

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Contractor Payment TermsT i l t i th t th t t ithi 30Typical terms require the owner to pay the contractor within 30 days of the pay application invoice. Consider the follow modifications: Payment period begins on the acceptance of a complete pay

application, not the pay application date Consider owner direct payment for major material purchases

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Right to Audit Language

This must be reviewed by your legal counsel prior to implementation:Right to AuditAvailability of Records. The records of the parties to this Agreement relating to the Project, which shall include but not be limited to accounting records (hard copy, as well as computer readable data if it can be made available; subcontract files (including proposals of successful and unsuccessful bidders, bid recaps, bidding instructions, bidders list, etc); original estimates; estimating work sheets; correspondence; change order files (including documentation covering negotiated settlements); backcharge logs and supporting documentation; general ledger entries detailing cash and trade discounts earned, insurance rebates and dividends; any other supporting evidence deemed necessary by Owner to substantiate charges related to thissupporting evidence deemed necessary by Owner to substantiate charges related to this agreement, and all other agreements, sources of information and matters that may in Owner’s reasonable judgment have any bearing on or pertain to any matters, rights, duties or obligations under or covered by any contract document (all foregoing hereinafter referred to as “Records”) shall be open to inspection and subject to audit and/or reproduction by Owner’s representative and/or agents of Owner. Owner may also conduct verifications such as, but not limited to, counting employees at the job site, witnessing the distribution of payroll, verifying payroll computations, overhead computations, observing vendor and supplier payments, miscellaneous allocations, special charges, verifying information and amounts through interviews and written confirmations with employees Subcontractors suppliers andinterviews and written confirmations with employees, Subcontractors, suppliers, and contractors representatives. All records shall be kept for seven (7) years after Final Completion.

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Right to Audit Language

Right to Audit Continued:Flow down.CM/GC and Architect shall require that all of their payees (including Architect’s Consultants, Subcontractors and Suppliers) comply with the provisions of the Right to Audit article by incorporating these requirements in all written contracts. This requirement to include flow down right to audit provisions in contracts with payees shall also apply to Subcontractors and Sub Subcontractors and Suppliers CM/GC and Architect shall cooperate fully and willSub-Subcontractors, and Suppliers. CM/GC and Architect shall cooperate fully and will request all of their payees to cooperate fully in furnishing or in making Records available to Owner, provided, however, the CM/GC and Architect shall not be responsible for any failure of Architect’s consultants, Subcontractors or Suppliers to comply with recordkeeping requirements after the date of Final Completion.

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Baker Tilly Webinar Series

Coming up in the Understanding Construction Contract Controls and Construction Audit BestContract Controls and Construction Audit Best Practices Webinar Series:

Construction Financial Controls and Contract ComplianceConstruction Financial Controls and Contract ComplianceWednesday, October 12, 201112:00 p.m. Central

Post-Construction Auditing and Fraud DetectionWednesday November 9 2011Wednesday, November 9, 201112:00 p.m. Central

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Register at bakertilly.com/construction-audit-webinar

Additional Resources

www.bakertilly.com/construction-audit-webinar http://www theiia org/ http://www.theiia.org/ https://www.thenaca.org/ http://www.caacci.org/ http://rsmeans.reedconstructiondata.com/ http://www.auditnet.org/

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Any Questions?

Please feel free to ask questions in the screen to your right.

We will answer as many questions as time permits.

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Contact Information

Tony OllmannTony Ollmann608 240 [email protected]@bakertilly.com

Erik Schuchardt608 240 [email protected]

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construction contract fundamentals · 2020-01-08 · about baker tilly >established in 1931...

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