CHAPTER EIGHT Payments and Contract Closeout 8.1 Invoicing and Verification The client is concerned with getting the work completed as specified, on or ahead of schedule, and on or under budget. Whether or not these aims are realized, the daily transactions of the contract must be supported throughout its life with auditable documents, right up to the final invoice and beyond. Unfortunately, fully executed documentation is not always on hand when it comes to paying the bill. The contractor wants to leave the job with its reputation intact (if not enhanced), but above all it wants to be paid regularly and on time. The regularity and the timeliness of its payments will depend to a large extent on the systems and controls adopted by the project. No client iinance department is going to pay the full value of an invoice on presentation and without verification. There must be an agreed method of checking that the work has been done or the milestones achieved. There must also be an agreed upon period between presentation and payment (usually about 30 days) for verification and clearance. In addition, the timing of invoice submission should be reasonable. It would be absurd for a contractor 205 206 CONSTRUCTION CONTRACTS to invoice every day or every time a yard of concrete is poured or a length of pipe is laid. Payment may be made against milestones achieved, progress per month, or on measured work. In certain situations, special arrangements may be made to allow frontend payments for mobilization, setting up of camps, and so forth. Even without these special arrangements, the contractor will be well advised to cram as much opportunity for frontend payments as it can into the agreement at the time of bid. To eliminate delay in payment, a cutoff date should be agreed upon for the month’s work, assuming payment is to be made against a percentage of progress or measurement or both. If the cutoff date is fixed at, say, the twenty-first of each month, the contractor would prepare a pro forma invoice to be presented to the site team for approval. This is where the contractor’s cost engineer or quantity surveyor and the client’s contract engineer are able to work in tandem to expedite verification and help sustain the cash flow. On receipt of the profomza invoice, the contract engineer will consult with the rest of the site team on the progress made by the contractor and will adjust the pro forma invoice accordingly. Eventually (but hopefully before the end of the month), an agreed amount is reached and the contractor may then present the invoice proper for payment. Ideally, both pro forma and final invoices should be divided into sections or work packages that represent the segments of the contract and total the original contract price with variation orders being kept separately. Payment will be made according to the terms and conditions of the original contract and subsequent variation orders. The finance or accounts payable department will expect verification of the contractor’s invoice by the site team but will also check the contract and variation orders to find authority for payment. In certain projects, this detective work is done by an offshoot of the finance department, known as “contract compliance,” that also has other functions of investigation as the title suggests. 8.2 Work Breakdown Structure Many client organizations use a “family tree”-type of subdivision of the complete project scope of work to provide the necessary framework for the establishment of project baselines for cost. This is known as cost control or work breakdown structure (WBS). Each contract in the project is Payments and Contract Closeout 207 identified as a branch of the WBS tree. A recent trend is to extend the WBS into the compensation section of the contract in the form of a series of work packages relating to the priced scope of work. In a $100 million refinery contract, for example, the work package may appear as follows (payment is to be made against monthly progress): Work Package No. 1. Site preparation 2. Fireproofing 3. Civil work 4. Mechanical work 5. Insulation 6. Painting 7. Electrical 8. Instrumentation $18,000,000 $2,000,000 $20,000,000 $10,000,000 $5,000,000 $15,000,000 $15,000,000 $15,000,000 Each work package will be broken down into identi–ible elements of work: Work Package No. 7 -Site Preparation Activity Description $ millions) Man-hours cost (US. Earthmoving 6,000 15,000 Trenching 3,500 8,500 Access roads 4,500 11,250 Grading 2,000 5,000 TOTAL 18,000 44,750 Paving 2,000 5,000 Assuming a lump sum contract and monthly progress payments, an agreement must be reached on the percentage of achievement of each work package, Table 8.1 is an example of a typical invoice summary. It is presented in the form of an accumulative value invoice indicating the cost of work performed to date, less the total value of all previous payments. Thus it reveals the actual value of all authorized work completed in the period. Table 8.1 shows that, barring change orders, the original contract value is depleted by 60.5 percent, leaving a balance of $39,500,000. Site preparation 208 CONSTRUCTION CONTRACTS Table 8.1 Invoice No. 01 1 (in U.S. $ mil1ions)forJanuary 2005 Work Package Contract Previously This Accumulative Description Value Invoiced Invoice Total 1. Site preparation 18,000 18,000 nil 18,000 2. Fireproofing 2,000 1,000 500 1,500 3. Civil work 15,000 12,000 1,000 13,000 5. Insulation 10,000 2,000 1,000 3,000 7. Electrical 15,000 5,000 2,000 7,000 4. Mechanical work 20,000 10,000 2,000 12,000 6. Painting 5,000 1,000 1,000 2,000 8. Instrumentation 15,000 3,000 1,000 4,000 TOTAL 100,000 52,000 8,500 60,500 Change orders TOTAL 20,000 5,000 25,000 72,000 13,500 85,500 Gross value of work from summaries: 85,500 Less amount previously invoiced: 72.000 Value of this invoice: 13,500 is 100 percent complete and paid for. The following progress was achieved for this month: Fireproofing 25% Civils 6.6% Mechanicals 10% Insulation 10% Electrical 13.34% Instrumentation 6.6% Painting 20% The client’s team will also be in a position to advise the finance department on the probable cash flow through the completion of the work and what should be reserved for payments in each future month. How many variation orders will be issued is not so simple to forecast but the contract engineer can probably offer an educated guess. 8.3 Measurement of Progress The verification of invoices relating to contracts with unit rate or bill of quantity arrangements may involve site-approved time sheets for manhours, measurements from drawings or profiles, or even physical checks Payments and Contract Closeout 209 such as weighing station tally sheets for truck loads or transit mixers. Where the contractor is engaged in a unit rate activity in which precise measurement cannot be guaranteed (e.g., in rock blasting and excavating for a pipe trench), physical methods must be abandoned for a theoretical calculated amount. Otherwise, the contractor would have no incentive to keep to the specification and, if it were paid for the rock and spoil actually removed, overblasting would be charged to the client’s account. In these circumstances, the contract would be written so that the client will pay only for theoretical quantities calculated in accordance with the standard in the area. The contractor will produce a profile and draw a cross-section of the trench that is checked against a cross-section produced by the client’s surveyor. Both parties will sign against the agreed profile as a base for calculation of theoretical quantities. This way, if the contractor blasts deeper than the agreed theoretical measurement, it does so at its expense. Measurement of progress from construction drawings, profiles, or isometrics is always preferable to physical measurement in the field. The drawing measurement is less costly and provides a record against which future progress may be compared. Where project engineering involves the production of a large number of isometric drawings, it is an advantage to have each isometric on the computer screen as soon as it is issued “Approved for Construction” so that future design changes or revisions may be measured against the original for addition to or deletion from the contract price using a variation order. 8.4 Retention It is customary for clients to pay only 90 or 95 percent of each invoice presented and retain the balance against the possibility of defective work or even abandonment of the work by the contractor. As each monthly invoice is submitted, the retained amount will accumulate until job completion is satisfactorily achieved. At that stage, half of the retention money will be repaid, leaving the balance to safeguard the work through the maintenance or warranty period, if the contract demands one. There are exceptions to the retention rule and in certain types of contracts (e.g., consultancies), the client may waive the requirement for withholding a percentage of the invoiced amount. A onetime invoice for work of a short duration may also be free of retention. Some clients do not extract retention from invoices 21 0 CONSTRUCTION CONTRACTS relating to change orders or compensation for standby periods. Although the latter concession is understandable, it is not clear why payment for extra work should be free of retention. It seems fair to adopt the general rule that payment for anything to be incorporated into the permanent works through the original scope of work or by change order should be subject to retention. Clients do not normally pay interest on the money they withhold, but a contract worth $100 million with a retention of 10 percent and a life of 12 months could realize over $600,000 if the contractor were able to invest that money instead of leaving it in the client’s hands each month. It is, therefore, a considerable saving to the contractor if it is able to negotiate with the client the acceptance of a bank guarantee in lieu of retention. It is an even greater saving if it can arrange a bank guarantee for each monthly payment as shown in Table 8.2. This table is offered as an example only because percentages or retention and bank charges differ from year to year and from country to country. Table 8.2 assumes that the contract price is loaded at the frontend for mobilization payments and for workload peaks between the fifth and eighth months. It also assumes that there will be no variation orders, or if there are, no retention or bank guarantees will be levied on them. An Table 8.2 Savings Realized fiom Bank Guarantees us. Retention Contract 10% Probable Bank Interest on Worth Retention Guarantee Charge Retention Invoices $loom =$lorn = 1.5% perannum at 10% 1st 1 5m 1.5m 22,500 2nd 5m .5m 6,875 3rd 6m .6m 7,500 4th 8m .8m 9,000 5th 1 Om 1 .Om 0,000 6th 12m 1.2m 0,500 7th 1 5m 1.5m 1,250 8th 1 Om 1 .Om 6,250 9th 9m .9m 4,500 10th 5m .5m 1,875 1 lth 3m .3m 750 150,000 45,834 50,000 60,000 66,667 70,000 75,000 41,667 30,000 12,500 5,000 12th 2m .2m 250 1,667 TOTAL 100m 1 Om 91,250 608,335 Note: m = million. Payments and Contract Closeout 21 1 imposition of retention on 10 to 15 percent extra work will, of course, make the bank guarantee that much more desirable. Further savings, for the contractor, may be achieved if the client will agree to impose retention or the bank guarantee requirement only on invoices directly related to the permanent work. A charge of 1.5 percent per annum of the amount guaranteed is mentioned as the probable fee charged by the bank, but much will depend on the contractor’s rating. It has been known for the contractor to hawk the contract around several banks and emerge with small parcels of guarantees because one bank would not risk the whole package. 8.5 Warranty Period When the contracted work has been completed to the client’s satisfaction, the agreement may then enter into a warranty period. During the warranty period, the contractor warrants that the works completed will conform to the drawings and specification and that they will be new and suitable for the purpose for which they were intended and will not be defective. The warranty period will begin at the issuance of the completion certificate given by the client to the contractor and will expire (usually a year later). If anydung goes wrong with the works during the warranty period, the contractor will be obliged to return to the site and put the matter right at its own expense. To encourage the contractor in this responsibility, the client will keep half of the retention on paid invoices until the end of the warranty period. In the case of the bank guarantee, the client will only release 50 percent of the guarantee. Some clients, on expiration of the warranty period, will issue a Final Acceptance Certificate and, at the same time, give back to the contractor’s bank or the contractor the balance of the guarantee or the remainder of the retention. 8.6 Contract Closeout When the last claim has been settled and the final invoice paid, the client will ask the contractor to sign a release confirming that no further monies are owed and there are no further claims to be considered. This “certification and release” sometimes accompanies payment of the final invoice. The format of the release document may vary between a simple agreement as shown in the following text and quite a formal affair couched in legal jargon and beginning with: 21 2 CONSTRUCTION CONTRACTS Know all men by these presents: For and in consideration of the payment to Contractor of the below balance by Company for labor, materials, equipment, and services furnished in connection with the performance of Contract No. -, Contractor – does hereby agree and acknowledge that the balance due for said labor, materials, equipment, and services is This continues for about another 200 words. The simple version, sometimes called the “final receipt and release agreement” merely states: In consideration of the payment by Company of $ less applicable deductions, Contractor hereby releases Company from any further liability of any nature whatsoever arising from or relating to Contract No. __ as it may have been supplemented or amended or arising from or relating to That is all there is to it, apart from provision for the signatures of both parties, and it seems to give sufficient protection within most organizations. For the contractor, much of what follows is fairly straightforward and it may silently fold its tents and steal away, laughing all the way to the bank or licking its wounds, as the case may be. For the client, however, there now begins the task of closing out the contract documents, writing the contract history, and recording the problems encountered and the solutions arrived at. Finally, the contract engineer will complete the “contractor performance evaluation” and when he comes to the question, “DO you recommend using this contractor again?” hopefully he will be able to answer in the affirmative. The client’s contract administration staff are among the first to be inducted into a new project and the last to leave the field. They generally remain to settle claims long after construction is completed and, of course, they close out each contract. On a large project, the closing-out process may take several months. The task of documentation is formidable. This is not to suggest that all the project contracts are saved until the very end before being completely discharged. The site preparation, civil, and other early contracts are closed out as soon as possible during the course of the project. However, the finalization of all documents for the mechanical, electrical, painting, and other contracts in the last stages of the project will continue long after the remainder of the construction team has departed. Payments and Contract Closeout 21 3 8.7 Contract Closeout Checklist For each contract, the contract engineer will complete a checklist of all actions necessary to close out the contract. Activity Status* Date 1. Contractor’s notice of completion 2. Outstanding requirements memo Input received from: Project Construction Construction manager Site superintendent Engineering Procurement InspectiodQC Cosdscheduling Accounts payable Contracts home office 3. All work orders finalized 4. All change orders finalized 5. All amendments finalized 6. Claims resolved 7. Back charges debited 8. Certification and release 9. Contractor’s final invoice 10. Final invoice approvals 1 1. Final invoice to accounts 12, Final payment to contractor 13. Bank guarantee 14. Retention 15. Contract closeout report 16. Closeout notice to contractor 17. Contractor performance evaluation 18. All closeout documentation files 19. Final acceptance *Note: R: received; I: issued; W: waived; C: completed; T: transmitted; N/A: not applicable. 21 4 CONSTRUCTION CONTRACTS On a large contract, the checklist may be in the contract engineer’s possession for some time and it will be advisable to prepare a note of activities that must be completed to satisfy each stage of the closeout process. When the contractor believes it has completed the work that it agreed to perform under the terms of the contract, the contractor will submit a notice of completion to the client. Usually, the notice is required within 10 days of the declared completion. The contract engineer will liaise with other disciplines to determine whether the contractor has indeed completed its obligations according to the contract. If this is not so, the contract engineer will issue a note of rejection to the contractor and will not proceed with the checklist until the contractor has rectified the outstanding deficiencies. Following settlement of all claims, back charges, and other credit and debit balances, all relevant invoices will be reconciled against the contract value together with all work orders, change orders, and amendments. This is done to ensure that final payment is inclusive of all financial arrangements and transactions of the contract. The contract engineer then prepares the contract closeout checklist that will eventually be distributed and placed in the appropriate file. For his own benefit he will compile the separate notes previously mentioned to assist him in the satisfactory completion of the checklist. These notes may take the form of questions as follows: 1. Confirmation from site representatives that all tests, inspections, and QA/QC matters are cleared? 2. All checklists well documented and on file? 3. Any credits to the contractor covering the value of work in the 4. Clearance obtained for the following technical documents required checklists that will not be completed by the contractor? by the contract? (a) Inspection release certificates (b) As built drawings (c) As built dossier (d) Mechanical completion file (e) Other with respect to company-issued material and contractor-furnished reimbursable materials? 5. Satisfactory material reconciliation data prepared by the contractor Payments and Contract Closeout 21 5 6. Scrap materials sold and credited to the company? 7. Surplus material from company issue transported to nominated 8. No back charges outstanding? 9. Final value of all work orders, change orders, and amendments agreed with the contractor? location and loaned supplies and equipment returned? 10. Retention details confirmed? 1 1. Bank guarantee details confirmed? 12. All claims settled? 13. Final account prepared and arrangements made for execution by 14. Site files complete and ready for shipment to the home office? 15. Site office closed and all office equipment not presently in use 16. All delegated signature authorities such as the site/company repre- 17. Contract Closeout Report and Contractor Performance Report completed? (See Item 8 on p. 2 19-Contractor’s Performance Report.) 18. Certification and release issued? both parties including release of claims? packed for shipment or returned to the contractor? sentative cancelled? The client may issue a provisional notice of acceptance in situations where the work is substantially completed and all tests passed to the satisfaction of the company representative. The contractor may provide a written undertaking to complete certain outstanding items by an agreed upon date. Details of a provisional notice of acceptance, should one be issued, will be included in the contract closeout report, which will also contain the contractor’s performance report. 8.8 Contract Closeout Report Note: All members of the client’s site team will provide information for this report but the contract engineer will be responsible for coordinating its preparation. Contents 1. Introduction and summary 21 6 CONSTRUCTION CONTRACTS 2. Commercial and financial 3. Contractual 4. Subcontractors 5. Material reconciliation 6. Technical documentation 7. Cost and schedule comparison 8. Contractor’s performance report 9. Photographs 1. Introduction and summary 1.1 Contractor’s name 1.2 Contractor’s address 1.3 Contractor’s representative 1.4 Description of the work 2. Commercial and financial 2.1 Final contract value $ 2.2 Agreement of final account Date agreed: 2.3 Retention Release of first half Date: Amount retained $ Release Date: 2.4 Bank guarantee(s) Guarantee amount $ Received Date: Accepted Date: Return Date: 2.5 Accounting-commitment Original commitment $ Add/omit to commitment: Work orders $ Amendments $ Escalation (if applicable) $ Change orders !# Total revision commitment $ 2.6 Reason for overhder-run of original commitment value: Payments and Contract Closeout 21 7 Original contract price $ Total work orders $ Total change orders $ Amendments to contract total price Total increase $ Final contract value $ 2.8 Insurance claims Amount claimed $ Amountagreed $ 2.9 Construction claims by contractor Amount claimed $ Amountagreed $ 2.10 Counterclaims and back charges by company Amount claimed $ Amount agreed $ 2.1 1 List of work orders $ Date Description Amount ($) 2.12 List of change orders Date Description Amount ($) 2.12 List of amendments to contract Date Description Amount ($) 3. Contractual 3.1 Contract document Execution Date: Completion Date: 21 8 CONSTRUCTION CONTRACTS Contract amendments Description: Execution dates: 00 1 002 003 004 3.2 Extension of time Initial extension: Subsequent extension(s): 3.3 Milestone completion certificates Description: Date issued: 3.4 Notice of rejection: Date issued: Notice of acceptance: Date issued: 3.5 Certification and release: Date issued: 4. Subcontractors Scope of work: Name: Scope of work: Name: 5. Material reconciliation 5.1 Details of scrap materials: Material: Quantity: Value of sale: Date of sale: 5.2 Details of surplus materials: Material: Quantity: Deposition: Transported: Stored: Location: Payments and Contract Closeout 21 9 6. Technical documentation 6.1 As built drawings Accepted: – Date: 6.2 As built dossier Accepted: __ Date: 6.3 Mechanical completion file Accepted: – Date: 6.4 Spare parts lists Received: __ Date: 6.5 Startup, operating, and maintenance manuals Accepted: – Date: 7. Cost and schedule comparison 7.1 Actual and planned progress comparison together with a weekly tabulation of progress is inserted here. 7.2 Actual and planned man-hour comparison 7.3 Actual and planned manpower comparison together with a weekly tabulation of manpower. 7.4 Contractor’s cost management report the contract terms if applicable. A graphical presentation of the actual and planned progress curve Final manpower (man-hour) performance report is inserted here. A histogram showing actual and planned manpower is inserted here This report should include contractor’s final cost in accordance with 8. Contractor’s pelformance report 8.1 Management and administration Engineering: Project Management: Procurement and subcontracting: Materials management: Construction management: Project administration (including contract administration, cost control, scheduling, and accounts): Adequacy of facilities: Overall: 8.2 Construction labor and foremen Attitude: 220 CONSTRUCTION CONTRACTS Workmanship: Productivity: Safety consciousness: 8.3 Cooperation with company: 8.4 Summary of strengths: 8.5 Summary of weaknesses: 8.6 Problems arising through contractual terms, conditions, inadequate contract language, and so forth: 9. Photographs Attach any photographs made throughout the course of the project that may be useful as a record of progress or outstanding activities such as heavy lifts, and so forth. The contract closeout report may take some time for the contract engineer to complete, mainly due to the difficulty of obtaining input from the various site team disciplines involved. It is not uncommon for the contract engineer to fill in the gaps when he finds that a site superintendent who promised the information has disappeared on another project. Eventually, the work is done and all that remains is to distribute an interoffice memo for signature by the company representative to the effect that work has been completed under Contract No. -, all monies owed and due to the contractor have been paid in full, and the contractor has furnished the company with a properly executed certification and release document to notify all interested parties that the contract is formally closed. In some organizations, the contract engineer will also prepare a letter to the contractor reminding it that the work has been performed to the full written acceptance of the company and all outstanding financial obligations against the work have been paid in full. The contractor is notified that the contract is closed and no further work will be performed and no further payment will be made. The letter may express the company’s appreciation for the manner in which the work in the contract was carried out and may assure the contractor that on future invitations to bid for work for which the contractor qualifies, every consideration will be given.