Essentials of a valid contract and general principlesiced.cag.gov.in/wp-content/uploads/B-02/Day 4...

An interaction on

Essentials of a valid contract

and general principles

sharing the experiences

Essentials Elements of a Valid Contract:

Essentials Elements of a Valid Contract:

1.Proposal and acceptance (NIT/RFP)

2. Consideration -- lawful consideration with a lawful

object

3. Capacity of parties to contract -- competent parties

4. Free consent

5. An agreement must not be expressly declared to be

void

6. Writing and Registration if so required by law.

Essentials Elements of a Valid Contract

7. Legal relationship

8. Certainty (No uncertian clauses : :Cost Plus & Lump Sum )

9. Possibility of performance

10. Enforceable by law

The contract-agreement should ensure :

• A definition of what is to be provided (clear) and requirements

(no idea) to be met (DMS-computerisation ops; IGNOU-ERP)

• An agreed level of service and mechanism for payment

reduction if not met (NQM Vs SQM-PMGSY)

• Means to measure performance

• Pricing mechanisms including where appropriate, milestone

payments, incentivisation/rewards, retentions and, if the

contract is for more than 2 years, price variation mechanisms


• A plan to cover implementation/transition/rollout

• Acceptance strategy/test plan

• Ownership of assets and intellectual property (Source

Code)

• Escalation and alternative dispute resolution procedures

• Change control procedures (IGNOU, DMS, IMO, OMMAS

PMGSY:Trg given but purpose not served, No Progress)

• Invoicing arrangements

• Communication routes , typically at three levels

• Operational (end users/technical support staff) Very Imp.

• Business (contract manager and relationship manager on

both sides)


• Strategic (senior management/board of directors)

• • Agreed exit strategy and agreed break options

• • Premises (where the goods/services will be delivered)

• • Sub contractor details

• • Authorities’ responsibilities (Expectations)

• • A good contract not only identifies clearly the obligations

of the provider, but also forms the foundation for a

productive relationship built on communication and trust

• A formal legal advice is always recommended prior to

making or accepting a contract.

GENERAL PRINCIPLES TO BE OBSERVED

The following general principles should be

observed while entering into contracts:

– The terms of contract must be precise, definite

and without any ambiguities. The terms should

not involve an uncertain or indefinite liability,

except in the case of a cost plus contract or

where there is a price variation clause in the

contract. (Most imp, route cause of disputes

later, in-depth knowledge and experience,

otherwise invites conditions in tender – not

alone a & d together; specs revised or not

available)


• Standard forms of contracts should be

adopted wherever possible, with such

modifications as are considered necessary

in respect of individual contracts. The

modifications should be carried out only

after obtaining financial and legal advice.

• In cases where standard forms of

contracts are not used, legal and financial

advice should be taken in drafting the

clauses in the contract.


Iv (a) A Contract document should be executed, with

all necessary clauses to make it a self-contained

contract. If however, these are preceded by

Invitation to Tender, accompanied by General

Conditions of Contract (GCC), Special Conditions of

Contract (SCC), with full details of scope and

specifications, a simple one page contract can be

entered into by attaching copies of the GCC and

SCC, and details of scope and specifications, Offer of

the Tenderer and Letter of Acceptance.

• (b) A Contract document should be invariably

executed in cases of turnkey works or agreements for

maintenance of equipment, provision of services etc.


• No work of any kind should be

commenced without proper execution of

an agreement as given in the foregoing

provisions.

• (vi) Contract document, where necessary,

should be executed within 21 days of the

issue of letter of acceptance. Non-

fulfilment of this condition of executing a

contract by the Contractor or Supplier

would constitute sufficient ground for

annulment of the award and forfeiture of

Earnest Money Deposit.

GENERAL PRINCIPLES TO BE OBSERVED• (vii) Cost plus contracts should ordinarily be avoided.

Where unavoidable, full justification should be

recorded before entering into the contract. Where

supplies or special work covered by such cost plus

contracts have to continue over a long duration, efforts

should be made to convert future contracts on a firm

price basis after allowing a reasonable period to the

suppliers/contractors to stabilize their production/

execution methods and processes.• Explanation : A cost plus contract means a contract in which the price

payable for supplies or services under the contract is determined on

the basis of actual cost of production of the supplies or services

concerned plus profit either at a fixed rate per unit or at a fixed

percentage on the actual cost of production.


• (viii) (a) Price Variation Clause can be

provided only in long-term contracts,

where the delivery period exceeds 18

months. In short-term contracts firm and

fixed prices should be provided for. Where

a price variation clause is provided, the

price agreed upon should specify the base

level viz, the month and year to which the

price is linked, to enable variations being

calculated with reference to the price

levels prevailing in that month and year.


• (b) A formula for calculation of the price

variations that have taken place between the

Base level and the Scheduled Delivery Date

should be included in this clause. Docs/Bases

for calculating variations should be specified.

• (c) The Price variation clause should also

specify cut off dates for material and labour, as

these inputs taper off well before the scheduled

Delivery Dates.


• (d) The price variation clause should provide for a

ceiling on price variations, particularly where

escalations are involved. It could be a percentage per

annum or an overall ceiling or both. The buyer should

ensure a provision in the contract for benefit of any

reduction in the price in terms of the price variation

clause being passed on to him.

• (e) The clause should also stipulate a minimum

percentage of variation of the contract price above

which price variations will be admissible (e.g. if

resultant increase is less than 2% no price adjustment

will be made in favour of the supplier).


• (f) Where advance or stage payments are made there

should be a further stipulation that no price variations

will be admissible on such portions of the price, after

the dates of such payment.

• (g) Where deliveries are accepted beyond the

scheduled Delivery Date subject to levy of liquidated

damages as provided in the Contract, the liquidated

damages (if a percentage of the price) will be

applicable on the price as varied by the operation of

the Price variation clause.

• (h) No price variation will be admissible beyond the

original Scheduled Delivery Date for defaults on the

part of the supplier.


• (i) Price variation may be allowed beyond the original

Scheduled Delivery Date, by specific alteration of that date

through an amendment to the contract in cases of Force

Majeure or defaults by Government.

• (j) Where contracts are for supply of equipment, goods etc,

imported (subject to customs duty and foreign exchange

fluctuations) and/or locally manufactured (subject to excise duty

and other duties and taxes), the percentage and element of

duties and taxes included in the price should be specifically

stated, along with the selling rate of foreign exchange element

taken into account in the calculation of the price of the imported

item. The mode of calculation of variations in duties and taxes

and Foreign exchange rates and the documents to be produced

in support of claims for such variations, should also be

stipulated in the Contract.


• (k) The clause should also contain, if necessary, the

mode and terms of payment of the price variation

admissible.

• (ix) Contracts should include provision for payment of

all applicable taxes by the contractor or supplier.

• (x) “Lumpsum’ contracts should not be entered into

except in cases of absolute necessity. Where

lumpsum contracts become unavoidable, full

justification should be recorded. The contracting

authority should ensure that conditions in the lumpsum

contract adequately safeguard and protect the

interests of the Government.

GENERAL PRINCIPLES TO BE OBSERVED• (xi) Departmental issue of materials should be avoided as far as

possible. Where it is decided to supply materials

departmentally, a schedule of quantities with the issue rates of

such material as are required to execute the contract work,

should form an essential part of the contract

• .(xii) (a) In contracts where government property is entrusted to

a contractor either for use on payment of hire charges or for

doing further work on such property, specific provision for

safeguarding government property (including insurance cover)

and for recovery of hire charges regularly, should be included in

the contracts.

• (b) Provision should be made in the contract for periodical

physical verification of the number and the physical condition of

the items at the contractors premises. Results of such

verification should be recorded and appropriate penal action

taken where necessary.


• ((xiii) (a) The terms of a contract, including the scope

and specification once entered into, should not be

materially varied.

• (b) Wherever material variation in any of the terms or

conditions in a contract becomes unavoidable, the

financial and other effects involved should be

examined and recorded and specific approval of the

authority competent to approve the revised financial

and other commitments obtained, before varying the

conditions.

• (c) All such changes should be in the form of an

amendment to the contract duly signed by all parties

to the contract.


• (xv) Normally no time extensions ( of delivery

scheduled or completion dates) except in events of

force majeure, or the terms and conditions include

such a provision for other reasons. Extensions so

provided may be allowed through formal amendments

to the contract duly signed by parties to the contract.

• (xvi) All contracts shall contain a provision for recovery

of liquidated damages for defaults on the part of the

contractor.

• (xvii) A warranty clause- requiring supplier to, without

charge, repair/rectify/replace defective goods; delivery

at the buyers premises.

• (xviii) A clause to reserve the right of Government to

reject goods which do not conform to the specs.

•

Thank You

An interaction on

Types of Contracts and the Distinctitive

Approaches and Methodologies in Audit

according to the type of Contracts,

interpretation of Contract Clauses

sharing the experiences

CONTRACT : DEFINITION A contract is defined as

• An agreement between two or more parties, with some

• legal binding enforceable in the court of law.

• A contract is a promise or a set of promises :

• for the breach of which, the law gives a remedy or

• the performance of which, the law in some way recognizes as

a duty.

• There are many stages involved in the formation and acceptance

of a legal contract. The basic stages of any contract includes :

proposal,

offer,

acceptance,

agreement and

consideration.

Types of Contracts

• There may be contracts for procurement of :

• Works,

• Goods,

• Services or

• Consultants/manpower

• PPP, etc

Some of the common types of contracts used in the

engineering and construction Projects are :

• Lump Sum Contract

• Cost Plus Contract

• Unit Price Contract

• Percentage (of Project cost ) or Fee

• Incentive Contracts

Lump Sum Contracts • Percentage (of Project cost ) or Fee

• Incentive Contracts

The contractor agrees to do a described and specified project

for a fixed price.

Often used in engineering contracts.

Also named "Fixed Fee Contract".

It is suitable, if the scope and schedule of the project are so

clear and sufficiently defined as to allow the consulting engineer

to estimate the project costs.

Cost Plus Contract• A contract agreement wherein the purchaser agrees

to pay the cost of all labour and materials plus an

amount for contractor overhead and profit (usually as

a percentage of the labour and material cost).

• The contracts may be specified as :

Cost + Fixed Percentage Contract

Cost + Fixed Fee Contract

Cost + Fixed Fee with Guaranteed Maximum Price

Contract

Cost + Fixed Fee with Bonus Contract

Cost + Fixed Fee with Guaranteed Maximum Price

and Bonus contract

Cost + Fixed Fee with Agreement for Sharing Any

Cost Savings contract

Cost Plus Contract• This type of contracts are favoured where the scope

of the work is indeterminate or highly uncertain and

the kinds of labour, material and equipment needed

are also uncertain.

• Under this arrangement complete records of all time

and materials spent by the contractor on the work

must be maintained.

Cost + Fixed Percentage Contract

Compensation is based on a percentage of the cost.

Cost + Fixed Fee Contract

Compensation is based on a fixed sum independent the

final project cost. The customer agrees to reimburse the

contractor's actual costs, regardless of amount, and in

addition pay a negotiated fee independent of the amount

of the actual costs.

Cost + Fixed Fee with Guaranteed Maximum Price Contract

Compensation is based on a fixed sum of money. The total project cost

will not exceed an agreed upper limit.

Cost + Fixed Fee with Bonus Contract

Compensation is based on a fixed sum of money. A bonus is given if the

project finish below budget, ahead of schedule, etc.

Cost + Fixed Fee with Guaranteed Maximum Price and Bonus

Contract

Compensation is based on a fixed sum of money. The total project cost

will not exceed an agreed upper limit and a bonus is given if the project is

finished below budget, ahead of schedule etc.

Cost + Fixed Fee with Agreement for Sharing Any Cost Savings

Contract

Compensation is based on a fixed sum of money. Any cost savings are

shared with the buyer and the contractor.

Unit Price Contract

This kind of contract is based on estimated quantities of items

included in the project and their unit prices. The final price of the

project is dependent on the quantities needed to carry out the

work.

In general this contract is only suitable for construction and

supplier projects where the different types of items, but not their

numbers, can be accurately identified in the contract documents.

It is not unusual to combine a Unit Price Contract for parts of the

project with a Lump Sum Contract or other types of contracts.

Incentive Contracts

Compensation is based on the engineering and/or contracting performance

according to an agreed target - budget, schedule and/or quality.

The two basic categories of incentive contracts:

Fixed Price Incentive Contracts (Lump Sum) :

Fixed Price Incentive Contracts are preferred when contract costs and

performance requirements are reasonably certain.

Cost Reimbursement Incentive Contracts (Cost Plus)

Cost Reimbursement Contract provides the initially negotiated fee to be

adjusted later by a formula based on the relationship of total allowable

costs to total target costs. This type of contract specifies : a target cost, a

target fee, minimum and maximum fees, and a fee adjustment formula.

After project performance, the fee payable to the contractor is determined

in accordance with the formula.

Percentage of Construction Fee Contracts

Common for engineering contracts. Compensation is

based on a percentage of the construction costs :

Planning & Architectural Works

DPRs preparations

Consultations

Designing & Drawing

Audit of ContractsBroadly Contracts relate to Procurement of :

A. Works

B. Goods

C. Services

D. Consultancy (manpower)

In PPP Mode

Accordingly,

• appropriate methods of procurement are adopted,

• contracts meeting the specific needs of the procurement are entered in to and

• Audit approaches and methodologies are decided.

We first discuss the common audit aspects and later share the Audit experience in each case.

Audit : Common Aspects

Info Analysis: Budget, Programmes and Schemes, Annual

Reports, Sanctions issued, Scrutiny of Govt Accounts received

in SAI office – especially the major payments , Internal Audit

Reports, Compliance with earlier Audits, Persistent Irregularities.

Minutes of the Project Progress/Review/ Evaluation/ Meetings

(incomplete/substantially time and cost over ran procurements,

arbitration cases, etc) , Quality Inspection Reports, Feed Backs

and Representations from Stack Holders, Media Reports, etc

Based on the initial study of the Schemes / Project Guidelines

select the Contracts and accordingly develop a strategy for

conducting contract audits.


Why and what of Contract Audit

•Contract audits common in both public and private

sectors.

•There are many reasons for conducting contract

audits,

•all related to risk management.

•Perform risk analysis of contracts to determine which

ones to audit.

•Contract risks include:

Time and cost overruns;


frauds; duplicate billing or billing of unrelated costs; compliance with government regulatory agencies; Abondoned WorksIncomplete procurementsSubstandard qualityOver-projections of BenefitsArbitration, etc

and many more.

Audit : Common Aspects Because of limited resources, it may be impractical or

impossible to audit all contracts. Resources may need

to be concentrated on new contractors and contracts

over a certain amount. Other factors to consider may

be the complexity of the contract, type of project,

importance or sensitivity of the project and regulatory

issues.

Decide who will conduct the audits: Assign specific

contracts to specific auditors or audit groups.

Obtain information to plan specific audits.

Audit : Common Aspects Auditors should obtain:

contract files,

budgets,

project and/or engineering plans,

accounting records

any other documents they need to plan the specific audits.

documentation of direct costs and indirect costs charged to

the contract,

records documenting compliance with contract provisions,

regulatory matters

and contract deliverables.

Audit : Common Aspects auditors should review these documents and update themselves on

the contract and to develop the audit procedures.

They should review these documents and update themselves

on the contract and to develop the audit procedures.

Auditors will need to obtain documentation of direct costs

and indirect costs charged to the contract and records

documenting compliance with contract provisions, regulatory

matters and contract deliverables.

Audit : Common Aspects They will verify billings from the contractor by

examining the contract costs incurred by the contractor.

Auditors will execute the audit procedures.

Auditors will select samples of direct and indirect costs

and test those costs to determine if they are allowable to

the contract in accordance with applicable criteria.

For government agencies, the criteria will include

government cost principles and the terms of the

contract;

for companies the criteria will be the terms of the

contract.

Audit : Common Aspects Auditors conduct an exit conference at the end of their

fieldwork.

They present the Auditee with a list of findings and issues to

be resolved.

The Auditee should be provided a reasonable amount of

time to review the list and produce any additional evidence

or information applicable to resolving the issues.

The auditors review the additional information and revise

their list of findings and issues for any that are resolved.

Auditors write the audit report, duly including the response

from the Auditee.

After the report is issued, the Auditee will agree or disagree

with the audit findings.

Audit of works Contracts

The aim of audit is to see that all works were executed within

the minimum possible cost and in accordance with the

procedure laid down for the purpose.

There are four main Stages connected with a project

clearance – which contain the contract management

problems which surface later:

1. Administrative Approval

2. Financial Sanction

3. Technical Sanction and

4. Appropriation or Re-appropriation of funds

Audit Points: contd..

Universal Audit Observations in India:

Time Over Run &

Cost Over Run Or

Efficiency : At the cost of Economy and Effectiveness

(anicuts)

Poor quality (Not yielding targeted results)

Incomplete/abandoned works; etc

Time Over Run :

Non Availability of the Project/Work Site

Change in Scope of Work – Inadequate surveys

Change in Design and Drawings – Inadequate

site/soil survey/technology-poor DPRs

Dispute with Contractor

Audit Points: contd..

Time Over Run continued :

Contractor has run away – Fin & Tech Bids /

inadequate capabilities.

For awarding work at Risk and Cost; formalities

are delayed or not completed.

Non/delayed availability of funds.

Progress monitoring mechanism not in place.

Delays in ATRs of quality monitors.

Works completed but final bill not setelled.

Cost Over Run: Adequate contractual capacity not available in the States. Award

at higher rates.

Adequate competition not generated:

e-procurement/tendering

Cost escalation due to time over run

Disputes with Contractor : Arbitration

Turn key Projects: Defective agreements/vague terms

and conditions.

LD charges are levied correctly and recovered.

Some Interesting Examples

Administrative approval (A/A): Necessity for the work by

the administrative department for Air strip but later

abandoned the work due to technical reasons .

A/A issued based on Guestimates (46/24 quarters At

Minimum possible cost) and necessary preliminary

plans (for land availability / basic amenities) not

provided.

Boulders/ Earth exacavated : for Land levelling – cost

and cartage.

Transformers procured but remained unutilized due to

change in scope of work.

Quality control (Mckinzys comparison of observations

of SQC and NQC) and action taken on the quality

related observations - effect in payment.

Maintenance – DLP –post construction : Pb case

DPRs/ Design and Drawings: To be based on proper field

and site surveys, necessary soil/field investigations

(seldom found/normally noticed at the execution stage in

the form of large deviations/variations in scope of

work/quantities)

Road alignments based on transact walk (normally

dispute with forest department/land owners)

Proper soil surveys in works (building , dams, canals

which do not come up timely or never used or

breached or washed away)

DPRs: Main problem in India. Quality

depends on accuracy of the data and facts

including technology (DPR preparation is

outsourced to consultants).

Comparison of work items and quantities

executed with those prescribed in the DPRs

(STAs view points, WBM v/s WMM, CD

works, CC works, etc.)

• Analysis of ALR and AHR in the financial bids,

justification/ markets trends (when prepared?)

• Bank guarantees genuine,

• Manintenace of contractor ledger, Inspection Book, Site

Register

• Comparison of items and quantities: between DPR & G

schedule and G schedule and MB (Normally financial

implications are checked)

• Final Bill pendency

When contractor leaves the work:

See his profile (works in hand)/financial standing

Technical evaluation

Recoveries

Invocation of BG and

Formalities for risk and cost award.

• Funds remain idle/Unspent Funds :Investment

Appropriateness of the action taken on the

observations of quality monitors

Comparison of observations of different quality

monitors

PPP

Huge infrasture being created

(roads/water/ellectricity, projects schemes etc)

their subsequent Maintenance and

Renewal

Huge funds are required and gain from the best

managerial and technical skills avalaible in the

private sector.

New ways of Financing

PPP contd….

Requirement of huge funds:

Tools for meeting funds requirement - Diferrent Models:

PPP - JVs and

Others:

BOLT (Built, Operate, Lease and

Transfer/MCA-TCS)

BOOT (Built, Operate,Own and Transfer)

BOT (Built, Operate and Transfer/TCS-

IGNOU)

SPVs (opens a company for the purpose)

PPP contd…Financing:

Toll (Estimation of Receipts & Payments/

Cost Benefit Analysis)

Cess on users who can afford (Mining and

other commercial users)

Annuity (Where Toll/Cess not possible):

Bunching to ivite financially and

technically sound big players.

Thank you

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