Sunday, July 28, 2013

Managing against changes and claims - a buyer's perspective for construction

In many parts of the world when you select the low bidder you will have one of two things occur. One is
You are dealing with the supplier or contractor that made the biggest mistake in their numbers. The other is they deliberately bid low. In either case one they have the award their goal will be to either make back the amount of their mistake or add to their profitability through changes and claims. As a result the contract manager of the buyer needs to manage the potential for both changes and claims.

The first place to start as a buyer is with the design. When I managed construction of buildings for an owner we would interview potential architects and engineers in advance and would review their work and samples of drawings and specifications. We would also get references and would check with those references about the frequency and nature of claims and would want to understand whether those were the result of problems with the architect or engineers design. Our list of potential designers would then be limited to experienced firms that showed that they had good internal quality control processes in place to avoid both problems with their designs or specifications. A problem to me is one where either the design in its current state cannot be build and requires modification or a design or specification that can have multiple interpretations, where the contractor assume the least cost option and you don’t want that.

While the design is in process you also want to pre-qualify your potential contractors or suppliers. I view pre-qualification to have multiple goals. First, does the supplier or contractor have the capability and capacity to perform the work? Second, each company has their own character and if you check customer references of the supplier you can understand what their character is like when it comes to both changes and claims. I normally seek to avoid companies that generate a high incidence of claims. Third, as part of the pre-qualification activity I also what see what the company does, how they do it, how they manage their work and their people. If I identify problems with what I see, I keep track of them so I can address them in the proposed contract. The last thing I use prequalification for is to uncover information that I can use in the negotiation or negotiation or claims. Many times a company may want to claim an extra charge for something you want them to do. If you have seen them routinely do that for all their work you viewed, I wouldn’t want to pay for what is really their standard.

In the contracting phase one of the most important things to include in a contract is a changes or variations clause where you limit the potential cost of any changes to cost plus a fixed percentage and required that the supplier or contractor provide you with documentation of the cost. The commitment to pay cost plus an agreed percentage should require the cost to be both actual and reasonable. You want actual cost so the provide invoices proving the cost. You want the requirement of reasonable cost as extra protection. You want protection against the supplier or contractor getting an inflated invoice from a sub-contractor or supplier that they frequently deal with and can dispute an invoice if its not competitive with costs others might charge. With respect to claims, one of the most important things to include is a requirement that the supplier or contractor notify you in writing of a claim and allow them a reasonable period in which to substantiate the claim and its cost. The last thing you want to do is come to the end of a long term contract and be flooded with a sea of claims and many of the project personnel who may have been familiar with it may no longer be working for the company or in that general. It much easier to understand the facts and take a position when you are able to quickly get all people involved in identifying the circumstances, cause, and impact of the claimed item.

In construction the next phase is the start-up phase. It is during the start-up phase when a supplier or contractor will propose the use of alternative materials or equipment. Some of the time those requests are based upon schedule needs where the item specified has a lead-time that would cause schedule problems. Many times the contractor or supplier may be proposing an alternative because it’s cheaper for them to purchase. This occurs frequently when a specification calls for a specific company’s product and allows “or equal”. The individual the manages any of these substitutions needs to do two things. First, they need to make sure that the change isn’t going to impact performance. Second, they need to understand any cost difference so they have that as a financial claim against the supplier or contractor.
Third, they need to look at the substitution from a total cost / total life cycle cost perspective. If the substitution is going to increase your total cost you want a further reduction to approve. For example
If the specified item had a three year warranty and the substitution had a two year warranty, the adjustment should include what your cost would be to purchase a service and maintenance contract for that year. For example if the specified item had lower energy consumption than the substitute, I would want the difference in cost over the equipment’s useful life to be deducted to make it equal.

In terms of the actual management of the work, there are a number of things that need to be in place. My contract management blog on my website has a number of tips on managing the work to avoid problems and claims,
Assuming contract management responsibility
Contract management as part of a team
Cradle to grave procurement contract management tasks
Dispute resolution
Establishing the contract file
Managing and documenting performance
Managing changes and the cost of changes
Managing claims
Managing amendments and change orders
Managing confidentiality or non-disclosure agreements
Managing payment
Managing bailed, loaned or consigned items
Managing terminations
Manage meeting minutes and correspondence.

From a claims management perspective these additional items need to be done:
1. The contract manager should review the contract and identify any deliverables that they or their separate contractors have to provide. With this list you create an internal action item list where you identify who owns the deliverable, when they have to provide it, the date they were notified of the deliverable, and the current status. This allows you to manage deliverables to avoid potential claims.
2. It should be clear to the supplier or contractor and their subcontractors on who has authority to order any changes to the work, as that can be a source of claims.
3. There should be periodic project meetings to review status, problems and deliverables.
4. As part of those meetings, the contract manager should establish and maintain an action item list where each issue gets documented, responsibility for correcting it assigned, date is was first raised is note and the current status get updated. The action item list should be used to expedite delivery of any owner or owner contracted companies deliverables to avoid potential claims because of delays in delivering approvals or materials.
5. Site supervision also plays a key role in managing potential claims. On major projects you will normally have a full site management office. One of their major responsibilities is to document all activities that occur on the site, deliveries made to the site and all items removed from the site. Those should all be consolidated into a site engineer’s log. That log should provide an excellent overview of what occurred on site on a particular date and is needed to manage and negotiate claims.
6. As work is being performed the engineer, architect or site project manager should also be maintaining a set of as constructed drawings and specifications that document what was changed, what change order or variation number that authorized the change, and when it was changed. As claims may apply to a specific date or time, if you update the documents you can see exactly what was required at any specific point in time.
The key in managing claims is to know what was required, what occurred, who was involved, and the impact.

Here is one example of how I managed a claim. I had an earth works contractor claim additional costs for removal and replacement of soil. I go a copy of the architect/engineers log of the work and our site engineer’s daily log. What I found was early on in the work the contractor had removed a significant amount of soil from the site. What I also found was the architect/engineer had instructed the contractor to stop uncovering as much soil as they were because they were concerned that the soil would be come unusable if it rained. The contractor continued to uncover large amounts against the architect’s instructions. It rained and the soil became unusable which force the contractor to being soil in and remove the unusable soil. I had evidence from the engineer’s log that showed how much had been removed from the site and that was more than they need to buy. So I didn’t agree to pay for the cost of their buying soil and trucking it to the site. I also had as evidence the engineers instructions not to uncover so much earth. I consider uncovering the excessive amount of soil to be a risk that they assumed.
What I offered to pay them was 1/20th of their claim amount. That equated to an amount that should have been reasonably uncovered that was now unusable and what it would have cost them to move it
from where they should have stored and protected the excess soils until completion of the work.