Project Management Institute

How PMs add value to contract management

Ernest M. DeLugo, Jr.

The following article outlines ways in which project managers can participate in project management before construction projects begin. The author emphasizes that early involvement of the project manager facilitates contract management and administration. The article concludes with practical steps that can be followed in contract negotiation and formulation. In sum, the author properly observes that investments made prior to commencement of the project reap handsome dividends in completion of the project on time and within budget.

Owen Shean, Legal Lights Editor

Investments made prior to commencing a project reap handsome dividends in completion of the project on time and within budget.

Typically, project contracts and documentation are produced by legal departments and administered by contract administrators, sometimes (and unfortunately) without the input or benefit of the project manager's experience. As discussed in this article, this experience is valuable when considering meeting schedules, controlling contractor's extra work orders, managing the contractor's adherence to work quality and performance, and reducing the possibility of contract disputes and litigation.

This article addresses the issues pertaining to procurement, construction, and performance type contracts. The word contractor is used in its most general sense. The terms vendor and subcontractor can be substituted.

The Role of the Project Manager

Simply stated, contract management (or administration) is the process of awarding a contract and ensuring that the contractor's performance meets contractual requirements. Specifically, it is the monitoring and control of the contractor's performance, including inspection and progress reviews; authorization of progress payments; work authorization management and approval; dispute resolution; and the recommendation of control modifications and approval of the contractor's actions to ensure compliance with contractual terms during contract execution. Since a contract is a legal document, it is imperative that the project team be acutely aware of the legal implications of actions taken when managing or administering the contract.

Communications and control are two key objectives of contract administration. When properly designed, the contract can be used not only to mitigate the adverse impact of the contractor's actions on the project but also to provide alternatives and remedies to the impact of external forces on the project. For these reasons, the contract is the single most important document that the project manager will use to control the destiny of the project. Since the contract is a key project management tool, it is critical that the project manager provide inputs and comments during the contract formation. The use of the project manager's experience during the contract design process will provide the following benefits to the project: coordination, quality feedback, ownership, feasibility, strategy formation.

Coordination. Since the project manager is involved in all aspects of the project and has knowledge of the product and process, making him or her a participant in the contract design process ensures coordination of all work requirements. On a multi-contract project, the project manager can help eliminate potential areas of conflict in work scope and contract requirements between the various contractors.

On a Detroit power plant project in Michigan, the city awarded six contracts for construction of various parts of the project. Each contract was administered by a different person, each with varying degrees of construction experience or background. The city's project manager was not involved until construction started on site. During the project's construction, the project manager was constantly besieged with extra work, extra costs, and delays associated with work, scope, and contract conflicts; plus unspecified but necessary work items. Certain basic construction requirements, such as soil testing and building painting, were not covered in either the structural or civil contracts. In addition, contractors were responsible for their own schedules; these schedules were not integrated into an overall master schedule. Because of this confusion and conflict, getting a handle on the monthly project progress was difficult and time-consuming. Early involvement could have caused the project manager to become the focal point for coordination of the contracts and schedules, and allowed him or her to provide the experience and oversight needed to make sure that all key construction requirements were specified and accounted for.

Quality Feedback. Early involvement by the project manager will identify problems encountered on prior projects. These problems can be discussed and preventive measures implemented prior to initiation of construction, resulting in a higher quality and more stringent control document. This feedback will help the contract team design a contract that will steer the project toward a successful conclusion while avoiding the mistakes of the past.

A project manager returning from the completion of a recycle tissue project in the southern United States was brought in early for the next assignment—another recycle tissue project—to discuss project problems and brainstorm preventive procedures. From this exchange the project manager was able to implement in the contract numerous preventive procedures and criteria peculiar to the technology and product. In addition, a dispute resolution system, which the project manager had used informally and successfully on the previous project, was incorporated to minimize and avoid contract disputes. The document's improved quality eliminated weak contractors from the bidding process. The project was completed two months ahead of schedule and $500,000 under budget, with no outstanding contractual disputes or litigation.

Ownership. By being involved in the contract design process, the project manager will have ownership of the contract and its supporting documents. This early involvement can initiate early team commitment, as the project manager leads and unifies the project team around the project objectives. All projects benefit from ownership by the project manager and the project management team. Early involvement also allows the project manager to promote early commitment and ownership from senior management.

Feasibility. Milestone schedules, construction methods, progress payment schedules, payment retention, and performance criteria specified in the contract will have the benefit of being reviewed in advance for feasibility and implementation capability by the project manager.

The completion date for the construction of a 100 megawatt, $130 million power plant in Florida was identified as being critical in the utility's power purchase contract. If the plant was not producing electricity by the contract completion date, the utility would have the right to revise the contracted price of electricity and possibly cancel the power purchase contract. Since the sale of electricity at the contractual price was an underpinning in the profitability of the project, a delay would have destroyed the financial returns to the project's investors. Approximately $6 million a year in investor income for 30 years was at risk.

Early in the contract formulation the project manager visited the site, identified construction hurdles, and determined that the time given to construct the plan was aggressive, risky, and probably was not feasible unless aggressive scheduling and planning was employed. Due to this evaluation, the construction contract was written to require that the contractor perform schedule acceleration wherever possible; hold project progress meetings every two weeks; procure all equipment where possible in the United States to avoid delays; and work scheduled overtime. In addition, a bonus for early completion was added to provide the necessary monetary incentive. The project was completed two weeks ahead of schedule and on budget.

Strategy Formation. Early involvement of the project manager embraces project management's commitment to an understanding of the project objectives, schedule, resources, and potential problems. From this, the project manager will be able to help the contracting team form a contract that will steer the project towards its desired conclusion while mitigating risk. This also provides the project manager with a timely definition of the types of personnel and talents needed to implement the project objectives. By defining those requirements early, the project manager can secure the needed human resources before they are committed to other projects. In some cases, this advance notification can initiate early or accelerated training programs if resources are determined to be deficient.

A tissue manufacturing plant had to deliver a certain daily rate of “to spec” high-quality tissue by a specified date in order for the purchase contracts to remain valid. These contracts were negotiated a year before construction and the contracted tissue price was now at a favorable price above the present market rate. In addition, in order to receive state grants and tax incentives, the plant had to hire 70 percent of its operating and maintenance personnel from the surrounding community—an area of high unemployment and no experience in the operation of this type of plant.

As part of the project management strategy, training was given a high priority and added to the project schedule and critical path. Vendor classroom training began six months into the plant's 14-month construction and operation schedule. The project's schedule strategy required that the plant's personnel, in order to gain further equipment familiarity, assist in the inspection and installation of the equipment. In addition, systems and equipment were split up into subsystems for immediate training and operation.

The plant was constructed on schedule. At the time of the plant's completion, the operating personnel had received eight months of quality training. Very often a plant, during its initial production, will miss production objectives and schedules as personnel and equipment struggle through the production learning curve. Due to the project manager's early emphasis on training, however, this plant exceeded its startup production goals and delivered a quality product months before the contract date. A tremendous accomplishment given the original quality of resources.

Experiences of a Project Manager

The following items should be considered during the contract formation. Not all items may be applicable to your projects, but they are an indication of critical contracting issues.

  • Provide contract language that requires the contractor to furnish “key” engineering drawings and schedules within 30 days after the Notice to Proceed. Failure to do so should be considered a major contractual commitment and an explicit condition for payment of mobilization or other draw requests. Key engineering drawings and schedules include the Project Master Drawing List; Engineering Procurement Schedule; Construction Progress Schedule (CPM), Electrical One Lines; P&IDs; Plot Plans; Heat and Material Balances; and Drawing Lists.
  • Provide contract language that requires that the Construction Progress Schedule and Engineering Design and Procurement Schedules (including milestones) be updated monthly. Failure to keep the schedules current should be a condition for penalties.
  • Require that the contractor provide supplier invoices and subsequent proof of payment for all expenditures along with the monthly draw request.
  • Require that, to the extent practical, all major equipment be factory coordinated and tested with their matching components from other vendors prior to shipment. There should also be a right for the customer's engineer to witness all shop tests.
  • Require that prototypes or “serial number one” equipment have extended warranties, i.e., greater than one year.
  • Hire an expediter to monitor and report on the production status of critical equipment. Vendors have been known to overcommit manufacturing capacity just to make the sale.
  • Request that spare parts for major pieces of equipment be received on consignment from the vendor. This will prevent a tie-up of cash in spare parts inventory.
  • Request that the contractor post a Letter of Credit for the startup period and a bond or Letter of Credit for the construction period.
  • Require that the contractor provide financial affidavits, at each draw request, certifying the financial condition of the company. Where possible, request actual financial statements.
  • Require that the contractor provide lien waivers from suppliers at each draw request.
  • Require that the contractor be responsible for any hazardous waste disposal and compliance with environmental regulations during the construction process.
  • Request that the contractor provide Builder's Risk Insurance and that it includes the cost of delay and transit coverage.
  • Establish a production shortfall or performance clause as part of the stated liquidated damages.
  • Require that the Force Majeure clause exclude site labor disputes. Force majeure events should also be the only unpenalized cause for schedule extensions.
  • Require a Schedule of Values (Earned Value Report) to establish the worth of certain tasks and milestones such as hardware fabrication, delivery, and installation.
  • Require that both the contractor and supplier be responsible for performing the Acceptance Test (including labor, materials, and supervision). The cost for these services shall be fixed and shall be part of the original contract cost. The customer provides monitoring personnel.
  • Specify a time limit on the contractor's obligations to fix equipment under warranty and remedy performance defects. The time limit expiration should trigger the award of penalties.
  • Require that the contractor submit its requests for progress payment using American Institute of Architects (AIA) forms G-702 and G-703. These are industry-standard forms that include built-in release of lien statements and a listing of change orders.
  • Design and incorporate into the contract a dispute resolution system. By planning ahead on how to handle contract dispute, you can mitigate the impact of disputes on the project schedule and budget. Litigation can even be avoided. An excellent book that provides guidelines for the system design is Getting Disputes Resolved: Designing Systems to Cut the Costs of Conflict by William L. Ury, Jossey-Bass Publishers.

Securing the Project's Success

Utilizing project managers at the early stages of a contract's formation can provide significant benefits to the project process. The cumulative effect of these benefits is that the project will be successful.

Ernest M. DeLugo, Jr., PMP, has over 23 years of experience in the management and financing of projects. He is currently a senior project management consultant for Educational Services Institute (ESI), an Arlington, Virginia, based project management consulting and training firm. Mr. DeLugo is also a member of the Southern New England PMI Chapter.

This material has been reproduced with the permission of the copyright owner. Unauthorized reproduction of this material is strictly prohibited. For permission to reproduce this material, please contact PMI.

PM Network • February 1995



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