Collaborative contracting is in principle about creating commercial alignment between contracting parties so that they could work together rather than against each other. This article is Part 3 of an article series examining collaborative contracting from a practical commercial perspective. In Singapore, NEC4 and PSSCOC (with bolted on Option Module E) are the two contract forms available for parties seeking to enter into collaborative contracting. One of the key elements in a successful collaborative contracting is finding the right reward system. Parties will naturally work together if the procurement pathway incentivises them to do so. Parties do not change their behaviour from that of adversarial to collaborative simply because of the label of their agreement. Psychological behaviours do not necessarily change by legal framework. By contrast, parties tend to collaborate naturally if the incentive structure is such that they tend to gain more, in an objective and measurable manner if they work together. By way of background and as alluded to in an earlier article of this series, collaborative contracting aims to address some of the shortcomings often found in traditional contracting model that is said to be adversarial in nature where parties operate based on a zero-sum game. Under traditional contracting model, parties’ interests are defined based on how risks are allocated. If certain risks allocated to the contractor materialise, the Employer ‘gains’ to the extent that its financial interest is cushioned by the contractor’s exposure. The reverse is also true. 

By way of illustration, if parties enter into a remeasurement contract, the Employer is financially exposed if the actual quantity of works turns out to be larger than estimated. In fact, the contractor’s profit level typically correlate positively with quantity of work done. This explains why the Employer favours lump sum contract where the situation permits. These scenarios underscore the reason why collaborative contracting does not generally work if the risk in hand predominantly affects only one party. Therefore part of the key considerations in setting up a successful collaborative contracting involve identifying reasons why parties should work together, mainly from a commercial perspective. In this regard, choosing the right procurement pathway that supports collaborative contracting is crucial. This invariably requires one to appreciate the ‘Main Option Clauses’ under NEC4 which consist of a variety of procurement pathways including Option A, B, C, D, E and F. Each option exhibit its distinct risks allocation characteristics, all of which will be examined further in the subsequent sections of this article. By contrast, the PSSCOC offers Option Module E as its bolt on clauses to cater to collaborative contracting. Under this contract form the number of procurement pathways available is relatively limited as compared to NEC4. As regards PSSCOC for construction works, the main procurement pathway is that of lump sum contract with pricing schedules that exclude quantities of works. As an alternative under its Option Module A, bills of quantities is used where such pricing schedule has both quantities of works as well as its associated unit rates. The bills of quantities could operate both as a lump sum contract (with quantities) or remeasurement contract. Under the latter option, the quantities therein are labelled as ‘provisional’. The availability of different procurement options and its potential effects on collaborative contracting will be examined further in this article. 

Ultimately contractors have very limited influence over the choice of contract form used as well as the procurement pathways included therein. The Employer as advised by its project consultants enjoys much of the discretion in these issues. This article hopefully will raise the necessary awareness for contractors to negotiate accordingly during tender. It will be somewhat odd for a collaborative contracting agreement that is not open to “collaborative tendering” where both parties take equal role in shaping the contents of their agreement.

NEC4 Main Option Clause – Option A (Priced Contract With Activity Schedule)

Option A of NEC 4 which refers to ‘priced contract with activity schedule’ resembles most closely with the default lump sum contract under PSSCOC Option Module E. Notwithstanding the resemblance, there remains some significant differences between these two contract forms under this procurement pathway. In essence, lump sum pricing in this regard shifts much of the pricing risks to the contractor whereby the contract sum shall be fixed to complete the construction works and only be adjusted where there are express provisions to do so. This pricing option is adopted when the project design is significantly developed with well defined quantities of work. If the Employer decides to revise any of its project design, the risk shifts back to the Employer in that it is required to compensate the contractor for any costs and/or time implications. Whilst the Employer typically favours lump sum contract due to its price certainty, it leaves very limited room to incentivise collaboration. By way of illustration, the Employer is quite unlikely to stipulate incentive payment under Key Performance Incentives/Indicator (KPI) if the contractor is able to achieve project completion at the existing lump sum price. This is because the Employer already enjoy price certainty under this mode of procurement, regardless of any incentive payment provided to the contractor.

Under Option A of NEC4 the accepted tender price which forms the contract sum (also referred to as ‘tendered total of the Prices’) is linked to the accepted construction programme. Construction programme is generally an aggregate of all construction ‘activities’ necessary to complete the project. The ‘activity schedule’ under Option A therefore refers to the entire list of activities found under an accepted construction programme where each activity is allocated with its cost. In other words, for any given activity parties are able to understand its duration as well as its costs. Therefore the sum of all costs allocated to activity schedule should be equal to the contract sum. The explicit linkage between construction programme and contract sum is not common particularly under standard forms of construction contract, certainly not found in the PSSCOC. This linkage in some ways increases time and cost transparency in relation to the project by allowing both parties almost equal access to contemporaneous project information. Asymmetrical information between parties is often the source of skepticism, which in turn inhibits collaboration. If and when a disruptive or delaying event occurs, both parties are most likely going to arrive at a similar view on its time and/or cost impact. This information alignment enables parties to collaborate on finding mutually agreeable solution by reducing the distractions of having to submit and review the associated claims. The following hypothetical example may assist in illuminating the collaborative effect.

For simplicity let us assume an accepted baseline construction programme that is structured such that the installation of facade panels to each building floor is categorised as a standalone activity, whereby the cost allocated to each activity is $100,000. Each activity duration is one week and all activities are sequenced consecutively. If a potential disruptive event stands to impact the installation activity of all three floors (namely all three consecutive activities) which warrants parties’ collaboration, the following information should not be disputed. (1) the cost of works that is subject to disruption is $300,000 (2) if the contractor is able to complete the works within the original planned duration by expending additional resources amounting to an overall installation costs of $400,000, the disruption cost should be $100,000 i.e. extra over from the original $300,000 (3) if no additional resources are expended to address the disruptive event resulting in completion of works by four weeks, the loss of productivity gave rise to one week delay. As these information was established prior to the occurrence of any disruptive event, it removes the distraction of advancing and assessing claims. Both parties should be able to work together since they operate based on the same set of facts. The information surrounding the hypothetical scenario above facilitates cost-benefit analysis e.g. whether it is sensible to expend $100,000 to avoid time delay of one week. As alluded to earlier, much of the parties’ willingness to collaborate depends on the existing risk allocation under the contract. If the contract is of a lump sum fixed pricing, and the delaying event is a risk shouldered by the contractor, the Employer clearly does not have any incentive to collaborate given the provision of liquidated damages. The reverse is also true if the delaying event results from the Employer’s breach of contract or caused by its act of prevention. Parties’ ability to collaborate (due to information transparency) does not necessarily equate to their willingness to collaborate. Certain contractually savvy party may even be hesitant to commit to any concession if it causes prejudice to its future legal position on the issue in hand.

Notwithstanding the above, the creation of cost loaded construction programme is often described as a fairly elaborate and effort intensive mode of contract administration. Some parties may understandably not favour such contract management approach especially if the project in hand may not have the type of risk profile that justify such methodology. Others may also view that the time and effort that may be expended to arrive at a mutually agreeable programme and activity schedule could involve extensive negotiation that runs counter to the principle of collaborative contracting. Those who subscribe to such views may prefer conventional lump sum contract under PSSCOC Option Module E. 

NEC4 Main Option Clause – Option B (Priced Contract With Bills Of Quantities)

Option B of NEC4 which refers to ‘priced contract with bills of quantities’ resembles PSSCOC with both Option Module A and E bolted on. In essence these procurement pathways are structured on a remeasurement basis where the contractor gets paid based on volume of actual work done on site. Such volume is then multiplied against unit rate included by the contractor in the bills of quantities. Unlike Option A where the contractor measures the quantities of work from tender drawings (therefore assumes the risk of under measurement errors), the bills of quantities are produced by the consultant quantity surveyor for tenderers to rely on for their pricing purposes. The term ‘remeasurement’ suggests that quantities included in bills of quantities are estimated and likely to vary from actual quantities, thus requiring progressive  follow up measurements throughout the project duration. In this regard, the quantity related risks are shifted to the Employer. The contractor on the other hand, assumes certain level of pricing risk by the adequacy of its unit rate which ought to encompass a blend of cost components e.g. plant, equipment, labour and construction materials for the relevant works. Whilst Option B of NEC4 is deemed remeasurement as a whole, Option Module A of PSSCOC is only remeasurement in so far as the relevant scope of works is labelled as ‘provisional’ pursuant to Clause A2.0(2). Therefore in the absence of ‘provisional’ label, the adoption of Option Module A under PSSCOC means ‘lump sum contract with quantities’ where the quantities shall not limit the contractor’s obligation to complete the works in accordance with the contract.

Option B of NEC4 is more likely used for infrastructure projects (e.g. laying of underground pipes, constructing roads and tunnels, foundation works etc) rather than building projects. Where a tender document for a building project includes bills of quantities, the building design should have been well developed to allow for measurements to be carried out. In fact most property developers may favour the use of bills of quantities as way of ‘verifying’ if the tender documents and drawings are sufficiently developed to allow tenderers to price meaningfully. Therefore, projects that utilises Option B under NEC4 are primarily confronted with uncertainties related to quantities rather than under developed design. In other words, much of the project risks are shouldered by the Employer rather than the contractor. This represent the opposite extreme end of the spectrum relative to lump sum contract. Again, any contract that has risks disproportionately allocated to one party does not incentivise collaboration due to the zero sum game nature. 

There are however limited circumstances where both the Employer and contractor may find synergy in collaborating under remeasurement contract. Although most remeasurement contracts are structured under traditional design-bid-build model, there are certain instances where the preamble to the bills of quantities may require that the unit rates provided by the contractor to include ‘all temporary/ permanent lateral support and soil stabilisation including any structural engineering design in compliance with prevailing regulations and codes’. In other words, where the contractor is required to carry out excavation works, it has to provide any proprietary design necessary to prevent soil from collapsing inwards. Therefore, the contractor assumes quasi design responsibility for the project. In this regard, it is in the interest of both the Employer and contractor to collaborate and change the existing engineering design by re-routing of services where necessary to avoid difficult locations which involved time consuming and costly construction works. This scenario presents mutually beneficial opportunity where the Employer stands to avoid schedule delay and the contractor is relieved from expending avoidable construction resources.

NEC4 Main Option Clause – Option C (Target Contract With Activity Schedule) And Option D (Target Contract With Bills Of Quantities)

Option C of NEC4 refers to ‘target contract with activity schedule’ whilst Option D of NEC4 refers to ‘target contract with bills of quantities’. Given that Option C and Option D are substantively very similar, these options will be examined jointly under this section of the article. By way of background, ‘target contract’ refers to the accepted tender offer which include final tender price that formed the parties’ agreement. The general idea is that this final tender price will become the initial basis of calculating pain/gain share mechanism. By way of simple illustration, suppose the parties split the pain/gain share by 50:50 and the final tender price is $1mil. If the final construction cost is $0.9mil, savings (gain) of $100k will be split equally and likewise any cost overrun (pain) beyond the target sum of $1mil will be split equally. The challenge however is administering the construction cost account in a transparent manner where much of the treatment of financial details are agreed upfront. In other words an open book approach is necessary. There is no equivalent provision under the PSSCOC Option Module E possibly due an extraordinary amount of contract administration effort that this option entails. Notwithstanding that having a target contract with pain/gain share mechanism aligns the parties’ financial interest considerably, arguably much more than either the remeasurement contract or lump sum contract. 

The open book approach under this option meant that much of the design to the construction works may not be fully developed at the point when the agreement is formed. This could either due to (1) the nature of the construction works which may involve underground construction with unknown soil conditions and subterranean obstructions, or (2) the contractor is engaged earlier than conventional timeline to assist with pre-construction activities as well as providing constructibility input to design development so as to assist with fast tracking project schedule. Therefore there are usually considerable level of uncertainty in respect of the scope of works at the point when the contractor is engaged. The project design may have been partially developed without the necessary details that are required for the tenderers to provide their lump sum pricing. In order to prevent scope uncertainty to fester into overall commercial uncertainty, parties agree on ‘Defined Cost’ and ‘Disallowed Cost’ in advance. As regards the former, the contractor will provide a discrete list of cost components which broadly represent resources necessary to carry out the works, whilst the latter represents cost that are not justifiably incurred by the contractor, if any which will be subject to deductions. The monthly progress payment will be derived based on the Defined Cost (subject to any deductions of Disallowed Cost) multiplied by Fee. Therefore, the contractor gets paid based on actual costs incurred (per Defined Cost) plus agreed fee (or profit) which are subject to site records and appropriate verification. This is why it is considered an open book approach.

Since Option C and Option D are based on an open book approach, what would be the purpose of establishing Activity Schedule and Bills of Quantities under the respective options? In short these pricing schedules are used to define the initial accepted tender price (i.e. target contract). Going back to the earlier simple illustration, it is used to establish the $1mil which in turn defines the basis of pain/gain share. Under Option C, the pricing schedule used is Activity Schedule (which is explained in detail under Option A) whilst Option D the pricing schedule is Bills of Quantities (which is explained in detail under Option B). However unlike Options A and B, these pricing schedules are not used to administer progress payments due to the open book approach. After all pricing schedules exhibit ‘prices’ rather than ‘costs’. It should be noted that the target contract which tracks the initial accepted tender price is not static. The occurrence of Compensation Events (i.e. delaying and disruptive events that could bring about time and/or cost implications) will be added to (or deducted from) the initial accepted tender price. Therefore the final pain/gain share is administered after considering cumulative financial implications of all Compensation Events. By way of illustration, if Compensation Events amounting to $300k is applied to the $1mil project, any gain share is split if the final construction cost is below $1.3mil. The reverse is true when it exceeds $1.3mil.

In view of the above, it appears that Option C and D seemed conducive for collaborative contracting given the alignment of financial interest between the parties. Perhaps the better way of describing these options is that it is ‘more conducive’ rather than ‘absolutely conducive’. This is because it can be both challenging and contentious to determine the cost and time impact of most Compensation Events when the project design is partially developed and the construction programme is not derived based on firmed scope of works. The basis of measurement can be vague when the benchmark of what constitute original scope of works is not crystallised. It is not straightforward to determine if any design initiative is a natural part of design development or a variation to the existing design. Therefore a successful implementation of Option C and D of NEC4 depends on parties’ ability to have clear delineation of responsibilities even if the design and scope of works are evolving. Some may argue that ‘clarity in ambiguity’ is an oxymoron. 

NEC4 Main Option Clause – Option E (Cost Reimbursable Contract)

Option E of NEC4 refers to cost reimbursable contract. In essence this is also an open book approach that is substantively similar to Option C and D explained above. The application of Defined Costs, Disallowed Costs and Fee are in place under Option E. However, target contract and the associated pain/gain share mechanism found under Options C and D are not applicable under Option E. This notable distinction also explains why Option E is provided for as a separate procurement pathway from that of Options C and D. Whilst reimbursable contract and target contract are adopted when the project design and scope of works are uncertain at the point when the agreement is formed, the extent of design uncertainty or fluidity generally differs between these options. Under target contract approach, the tenderers are able to populate their indicative pricing into the Activity Schedule or Bills of Quantities as the design available is likely to be at the stage of schematic design or concept design. Therefore whilst the tender drawings are not sufficiently developed to commence construction works, it is sufficiently informative to facilitate indicative pricing. Reimbursable contract under Option E on the other hand is likely to be confronted with much less design at the point when the contractor is engaged. This is likely to be the choice of procurement pathway when the project in hand may be prototypical in nature and any pricing provided are unlikely to be commercially meaningful. Therefore, ‘accepted tender price’ is not suitable for administration of pain/gain share mechanism. After all pricing can only be as accurate as the definition of scope of works. 

The parties naturally place more emphasis on Defined Costs, Disallowed Costs and Fee as the basis of making interim progress payments. The great degree of uncertainty in scope of works in turn makes any reliance on the baseline programme to be challenging. Therefore any assessments of Compensation Events are primarily based on unit rates found in Defined Cost or provision of advance quotations by the contractor.

It is therefore fair to say that under Option E of NEC4, the risks allocation is disproportionately placed on the Employer. Some may argue that the contractor will find limited commercial incentive to collaborate (apart from establishing positive working relationship for prospect of future businesses). Productivity and commercial efficiency are unlikely the contractor’s foremost considerations since it will be mostly reimbursed for cost incurred (plus profit). There is no equivalent procurement pathway under PSSCOC Option Module E, although the use of daywork rates as one of the methods to value variations exhibit certain resemblance to Option E of NEC4. Whilst the risk allocation may not be appealing to the Employer, this is a useful procurement pathway if the Employer is embarking on construction of certain highly unique and prototypical facility with an aggressive schedule. It allows a great degree of overlap between preliminary design and construction activities.

NEC4 Main Option Clause – Option F (Management Contract)

Option F of NEC4 refers to management contract where not only the contractor is relieved from most of the commercial risks much like Option E, but the Employer also takes a lead role in identifying specialist contractors and trade contractors to execute the construction works. The term ‘management contractor’ therefore means a contractor that primarily plays a management role in coordinating and supervising these specialist contractors by engaging them directly as subcontractors. The contractor is expected to have very limited responsibility in carrying out any of the works apart from the oversight responsibility. Whilst the Employer does not have any direct contractual relationship with these subcontractors, it is expected to pay the management contractor an agreed fee for its management responsibility and in exchange for the contract privity. Since the contractor is not expected to carry out much of the works, the Defined Cost under Option F is mainly payments due to the subcontractors rather than unit costs and rates submitted by the contractor for the works. Some have described the management contractor as a ‘payment conduit’ to the subcontractors. There is no equivalent procurement option under the PSSCOC Option Module E.

As mentioned earlier, Option F under NEC4 has significant impact on parties’ collaboration since much of the commercial risks rest on the Employer. It is noteworthy that Option F in this case not just affect the contractor’s willingness to collaborate but also its ability to do so given that it has very limited responsibility in carrying out the actual works on site. Much of the specialist subcontractors are likely procured and ‘nominated’ by the Employer to the contractor. Therefore the contractor’s influence on the actual work done on the ground is relatively limited as compared to other procurement pathways previously mentioned. In this regard, the contractor is occasionally viewed as a proxy of risks on behalf of the collective subcontractors.

Conclusion

The choice of procurement pathways can have a significant impact on the success of collaborative contracting perhaps superseding the other of its general features e.g. key performance indicator (KPI), early notification register, partnering workshop etc. The main reason for such overwhelming influence of procurement pathway is due to its underlying premise of risk and reward ratio. Parties are more likely to collaborate not when they are contractually obligated to do so but rather when they are financially motivated to act in mutual interest.

Koon Tak Hong Consulting Private Limited