Category: Contracts

In previous posts, have discussed various kind of Contracts based on the Nature of Transaction, Mode of Project Delivery and Compensation Methods.

The next step in the journey is to learn How to Draft a Good Contract, which is simple, error free and easy to execute. In this post we are going to discuss 6 important Contract Drafting Rules necessary to form a dispute-free contract

Contract drafting highly specialized skill

Contract drafting is highly specialized skill and requires lot of experience, maturity and wisdom. Moreover, the contract writer should have good understanding of industry practices and in-depth knowledge of contract & procurement laws.

In addition to the above, contract drafting requires a different attitude and mind-set. This is because any extreme (or casual) approach could make the agreement VOID or impossible to operate. Consequently, it may render the contract subject to litigation thereof. This situation may result into wastage of lot of time, money and efforts. Even if the things do not go to such extremes, poorly drafted contracts could lead to lot of confusion and misunderstanding. As a result, it could give room to unnecessary correspondence and contractual tussle between the parties thereby defeating the intended purpose.

Contract should be easy to understand and interpret

Our ultimate purpose should be to draft a contract which is easy to understanding and interpret. Accordingly, we need to draft contractual provisions in such manner so as to avoid confusion, discrepancy, more than one interpretation and misunderstanding between the parties.

We can achieve this objective by followings certain rules while drafting a contract. These rules are called Contract Drafting Rules and 6 of them are mentioned below;

1. Use appropriate language
2. Avoid Contradiction
3. Avoid Duplication
4. Use References & Cross-references
5. Mutually explanatory & complementary clauses
6. Maintain Uniformity and consistency.

In this post let us discuss first two (2) rules. Balance 4 rules shall be discussed in next post

6 Contract Drafting Rules:

1. Use appropriate language:

This is one of the most important Contract Drafting Rule because Contracts are written and interpreted in English or another language. For seamless execution of the contract, it is imperative that both parties draw the same meaning from the contract clauses. Moreover, parties should understand their rights and obligations in the same sense.

In view of the above, let us consider the followings aspects regarding language while drafting a contract

• Use language which is easy to understanding and interpret.
• Choose most appropriate words as used in day-to-day communication
• Say no to complicated vocabulary, harsh or punitive words
• Say no to emotions and adjectives

2) Avoid Contradiction:

Contradiction means conflict between two or more provisions. Two or more provisions are said to be in contradiction when they lead to different or opposite meaning. For example, one provision says that Time for Completion is 12 months and another provision says that Time for Completion is 9 months

A large Contract generally consists of various documents such as:

• Contract Agreement
• Letter of Acceptance
• Particular Conditions of Contract
• General Conditions of Contract
• Technical Specifications
• Data Sheet & drawings
• General Technical Requirements

All the above documents are integral part of the Contract. Also, each document consists of various clauses and sub-clauses that define the rights and obligations of the parties. Accordingly, we should draft all such documents with due diligence so that there is no contradiction between various clauses of a particular document or across different documents.

The above is critical because otherwise it may invite dispute. This is because each party starts referring to those provisions which suits them the most. Both parties become adamant and stick to its stand and use all tricks to prove its points. So it becomes very difficult to resolve the matter or to ascertain who is right. The end result is a lot of wastage of time and effort due to unnecessary correspondence, discussion and meetings.

The contradiction arises, because as a normal practice, a contract document is reviewed by different stakeholders. Accordingly, cross-functional team starts making changes in certain provisions of a document or in a particular clause as relevant to them. However, they missed to make corresponding changes in other clauses or in other documents, as deemed necessary in the context. As a result, we end up forming a Contract with lot of contradictory provisions

Please refer to next post for balance 4 rules

Please read disclaimer statement by clicking: Disclaimer Statements

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In the last post we discussed that various contracts type based on compensation method may include Lump Sum, Item Rate and Cost Plus Contracts. Also, we further discussed about Lump Sum Contracts. Please click on the link below to read this post

Difference Among Lump Sum, Item Rate & Cost Plus Contracts

In this post, I wish to explain Item Rate and Cost Plus Contracts in more detail. In construction industry, there is enough use of item rate contracts especially for the execution of civil works by Contractor as per Owner’s design. However, Cost Plus are not so common and we see them rarely

Contracts Classification based on Compensation Method

B) Item Rate Contracts:

Item Rate means “contract price” for “unit quantity” of each “work item” as defined under scope of work. Sometime it may not be possible for the Owner to ascertain exact quantities for identified work items. This may happen because of the nature of the work, and/or design not fully completed and/or some inputs are missing to ascertain exact quality. So, the Owner stipulates the “estimated quantities” of each work items. Accordingly, the quantities, finally executed by Contractor, may be different. Therefore, in these circumstances, where quantities are likely to change, it is not prudent to invite Lump Sum Price or sign a Lump Sum Contract. Here Item Rates Contract (i.e. unit price contract) seems best fit, as it extend flexibility to address “quantity changes” within certain range (as agreed by parties), without any need to follow lengthy Variation & Variation Order Procedure.

In Item Rate Contracts, Owner defines the comprehensive Bill of Quantities, which consists of detailed description of Work Items, Unit of Measurement and estimated quantities. Accordingly, Owner invites and bidder quote the “Rate/Price” for “unit quantity” of each BOQ Item. Such contracts where different unit price exists for respective BOQ Items are called Item Rate Contracts.

Unit Rates contractually binding, not total price

The Unit Rate mentioned against each work items is the “contract price” for “unit quantity” of such item. Therefore, it is a contractually binding price. However, the item price which is obtained by multiplying the unit price with estimated quantity is a notional price. The actual item-wise price to be paid contractually shall depend upon the actual executed quantities.

Subject to other contract conditions, Owner is bound to pay for actual executed quantities based on the Unit Prices stipulated in the Contract. This is true as long as actual quantities do not vary beyond the prescribed limits. Total Price which is obtained by adding the item price of all BOQ items is again the estimated Total Price rather than Total Contractual Price. Total Contract Price (or Contract Price) as stipulated in the item rate contracts is necessary for the purpose of ascertaining BG or LD Amount. However, it does not dilute the spirit of Item Rate Contracts

C) Cost Plus Contracts:

In certain situation, in view of nature of work, it may not be possible for the Owner to clearly mention work items as well as quantities with greater certainty. So the scope of work is a stipulation of final requirements with a general description of work items and tentative quantities. Also, there is a high probability that the work items and/or the associated quantities may change.

Therefore, in the above circumstances, it would not be possible for the contractor to quote Lump Sum Price or Unit Rates because both work items and quantities are not fixed. Hence, it is prudent to select a reputed contracting organization having versatile experience and enter onto Cost plus Contract. Under such contracts Owner pay the contractor based on actual cost incurred plus reasonable profit.

Significance and relevance of cost plus contracts

Cost Plus Contracts are best fit and most suitable when there is high degree of uncertainty in the scope of work and both work items & quantities are likely to change. This mainly happened for scope of work where:

a) industry practice is not established
b) scope of work is entirely new or some thing totally different
c) work is being executed first time and
d) Owner and/or Contractor have not executed similar work in the past
e) Owners and/or Contractor are not able to estimate the cost with reasonable accuracy

Disclaimer Statements

In the previous post, we covered the contract classification based on Nature of Transaction and Mode of Project Delivery. Accordingly, we discussed the difference among Supply, Service Contracts & Works Contracts and among EPC, EPCM and Multiple Packages Contracts

In this post, we are going to discuss various kinds of contracts under the broad category called Compensation Method / Method of Payment .

One organization may prefer to pay Lump Sum Price for the entire scope of work. However, other one may choose to pay based on rates agreed for each work item multiplied by corresponding quantities. Yet a third one may like to pay the contractor based on the actual cost incurred plus reasonable profit. Each type has its own merits and demits and no one is absolutely wrong or right.

Based on the Compensation Method, contracts are classified as follows;

A) Lump Sum Contracts
B) Item Rate Contracts
C) Cost plus Contracts

We deal with such contracts very frequently in our work life. The purpose of this post is to understand the significance of each type and eventually know their distinguishing features. This will help to choose the right fit for a given situation. 

Let us now discuss above contracts in more details

Classification based on Compensation Payment

A) Lump Sum Contract:

The word lump means to combine, aggregate, bunch or consolidate. The word Lump Sum means Aggregated Amount or Consolidated Amount.

As the name suggests, Lump Sum Contracts consists of Total Consolidated Amount against the given scope of work. In such contracts, Owner defines detailed Scope of Work and/or Materials to be Supplied and/or Services to be rendered by the Contractor and as required to execute and complete the work. And, Owner invites Total Aggregated Price from the bidders for the entire scope of work.

Consolidated Price which include all associated costs for all supplies and services is called Lump Sum Contract Price. Lump Sum Price is a consideration for all liabilities and obligations of Contractor. Also, this lump sum amount is a contractual price between the parties. Consequently, Owner is bound to pay such price as long as the scope of work remains unchanged. Any further break up of Total Price in the form of Price Schedule/Priced Bill of Quantities is to facilitate payment. Existence of item price, sub-component or component price in the Price Schedule does not dilute the essence of Lump Sum Contract

Significance and relevance of Lump-sum Contracts

Lump Sum Contracts are very common industry practice for procurement of engineered products, specialized services and for execution of design-build & EPC/Turnkey Contracts. Owner prefers to obtain lump-sum price so as to ascertain the Total Cost before starting the works. Also, it is easy to compare various offers when received on the basis of Lump-sum Price. By doing so, Owner transfer the risk of quantity variations to the Contractor

Lump Sum Contracts are best fit and most suitable when there is a full clarity on the Scope of Work. This means works items and quantities are known with greater certainty and the probability of scope/quantity change is comparatively less. This mainly happened for execution of works where industry practice is established and when bidders have full understanding of scope and enough prior experience to accurately calculate and quote the Lump Sum Price and successfully perform the awarded works

Item Rate and Cost Plus contracts shall be covered in the next post

Disclaimer Statements

In the last post we discussed Indian Contract Act, a statue applicable to the contractual relationships between the parties. Please click on the link below to read the post again

http://www.rkstrainings.com/indian-contract-act-law-governing-contracts/

In this post we are going to discuss Sale of Goods Act, a specific law related to sale/purchase of good

Sale of Goods Act

Sale of Goods Act, 1930 is the another most important and relevant Business Law for Contracts and Procurement. This law was enacted in 1930 and known as Sale of Goods Act, 1930. The statue came into force on 1st July 1930 and was drafted based on English Sale of Goods Act, 1893

The Act defines set of rules with regards to Sale of Goods. The Statue deals with transaction of sale/purchase of moveable goods between buyer and seller. The term “Goods” is clearly defined under the law and hence statue apply to the things covered in the definition. This act provides the norms with regards to: Formation, Performance and Suit for Breach with regards to the Contract of Sale of Goods between the buyer and seller. It also provides stipulations regarding the rights of buyer and un-paid seller

Sale of Goods Transaction

Chapter VII of Indian Contract Act, 1872 also lay down certain provisions in relation to Sale of Movable Goods. However, subsequently, after few decades, environment of business & trade undergone substantial changes. Hence new relationships developed between business entities. So the provision of Chapter VII of Indian Contract Act appeared to be inadequate to address issues concerning mercantile transaction

Accordingly, need was felt to enact a new law that exclusively set forth the specific provisions in relation to sale/purchase dealings of modern business relationships/methods. However, general provision of Indian Contract Act will continue to apply to newly enacted Sale of Goods Act

Sale of Goods constitutes the majority share of all the business transaction undertaken across the globe. So a thorough understanding of this act is important to fully appreciate the subject

Relationship of Sale of Goods Act with Indian Contract Act

Indian Contract Act and Sale of Goods Acts are: related, interdependent & complementary. They are not totally independent statues. This is clear from the followings provisions of Sale of Goods Act 1930

• Chapter 1, Section 2 – Definitions, Serial No (15) of Sale of Goods Act, 1930 says that the expression used but not defined in this act and defined in Indian Contract Act, 1872 have the meaning assigned to them in that act
• Section 3 of Sale of Goods Act, 1930 titled Application of Provision of Act 9 of 1872 stated that all such provisions of Indian Contract Act, 1872, if not inconsistent with express provisions of Sale of Goods Act, shall continue to apply to the Contract for Sale of Goods
• Sale of Goods Act uses terms such as Contract of Sale of Goods or Agreement to Sell, Offer, Acceptance, void & voidable contracts. The true meaning of such terms has been defined in Indian Contract Act, 1872
• Sale of Goods Act refers to the Indian Contract Act at number of places. So, this act is a specialized branch of Indian Contact Act rather than a distinct act

Indian Contract and Sale of Goods Act not mutually exclusive

From the above, we can say that two acts are not mutually exclusive. Actually they do consist of common term and overlapping provisions. Hence both Acts must be read together to draw a full understanding on the subject. Sale of Goods Act, 1930 is subsequently step to provide specific provisions in relations to Sale of Goods while keeping the fundamental & general provision of Indian Contract Act, 1872 intact and applicable thereto

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Disclaimer Statements: http://www.rkstrainings.com/disclaimer-statements/

Dear Readers,

In the last post we discussed Contract Life Cycle and its 4 stages. Please click on below link to read this post again

http://www.rkstrainings.com/contract-life-cycle-and-its-various-stages/

In this post, we are going to discuss the meaning and definition of other key terms related to Contracts i.e. Contract Formation, Administration and Management. Contract life cycle explains the activities under Contract Formation and Administration.  This post will clearly bring out the difference between Contract Administration and Management

The above discussion will eventually give a clear overview of Contract Management Process

Difference between Contract Administration and Management

A) Contract Formation

This process starts after receipt of user requirements and ends when Contract is signed with selected vendor. Contract formation process commence upon sending RFQ/Enquiries to identified bidders/agencies. It continues until offers received, technical and commercial evaluation completed, price agreed and LOA issued. The process ends when both parties sign the formal agreement

Let us understand Contract Formation Process in context to painting example

We know that objectives in term of Scope, Time, Budget, and Quality are set under stage 1 of Contract Life Cycle. So, the next step is to identify and appoint a painter who is a best fit for meeting such objectives. We achieve this by undertaking following steps

1. Identify 2-3 potential painting agencies
2. Send RFP/Enquiries (with requirements: Scope, Time, Quality) and invite offers from agencies identified
3. Receiving offers and evaluating against set requirements
4. Shortlist agency who meets most of requirements & offer better price
5. Discuss, negotiate and agree upon the final price and payment terms
6. Put all agreed terms on a piece of paper and sign the agreement

Contract Formation is a pre-award process because it covers all activities until Contract Award. Because it starts with PR and ends with PO (Contract Award), we also call it Purchase Requisition (PR) to Purchase Order (PO) Process

Contract Administration

Contract Administration is a process that involves all activities undertaken by Owner to ensure receipt of goods/services or completion of works as per the contract thereby meeting the intended contract objectives. This process commences upon Contract Award. It continues until goods/services received or work completed, payment made, claim settled and all contractual obligations met by both parties. This Process ends when the contract is formally closed

In context to painting example, here painter carryout the painting work as per Contract and Raj makes due payment to painter. Once both parties have completed their respective obligations to the satisfaction of each other, they formally close the Contract and come out of the binding relationship

Contract Administration is a post-award process because it covers all activities after contract award. It is also called PO to Closeout Process because it starts with PO (Contract Award) & ends with Contract Closeout

The process focuses on getting goods/services/works of requisite quality, on time and within Contract Price

Contract Management

Contract Management is a process of entering into a Contract with vendor/contractor for meeting certain objectives and undertaking Contract Administration for achieving such objectives through performance by each party as per Contract. This is broader term which includes Contract Formation, Administration and Closure

From the above, we can say that:

1) Contract Management = Contract Formation + Contract Administration
2) Contract Management = PR to PO Process + PO to Closeout Process

The above explanation brings out the difference between Contract Administration and Management. In other words, Contract Management is a larger process and Contract Administration is one part of it

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Disclaimer Statements: http://www.rkstrainings.com/disclaimer-statements/