Contract Risk Assessment

CONTRACT RISK ASSESSMENT TO THE PERSPECTIVE OF A CONTRACTOR

CHAPTER 1

INTRODUCTION

People say risk is unavoidable in life, and that’s probably true.

However, risk is not necessarily unavoidable when it comes to the contracts

you enter to.

Risk analysis and Risk allocation in the construction industry is established

through the construction contract. Accordingly, when drafting their standard

agreements with subcontractors, general contractors frequently incorporate

multiple provisions that have the effect of transferring liability to the

subcontractors.

The logic expressed by the general contractors is that risk should be

allocated to the party that is in the best position to manage it. In reality, it

frequently happens that the party with the strongest bargaining position gets

to allocate the risk in a contract.

As the risk-sharing provisions in domestic public construction contracts are

not completely fair and reasonable, contract disputes often arise as a

result which in turn cause delays, quality impacts, and other problems

that urgently need improvement. Introduced in this article is the

development of a decision system for risk-sharing in public construction

contracts. Said system was developed through literature review, fuzzy

synthetic evaluation in conjunction of analytic hierarchy process, definition

Radhika,Rohit,Prathmesh Page | 1


of risks in public construction contracts, and establishment of decision

models for risk-sharing. Subsequently, the "escalation" risk was employed

as an example to select suitable decision models for analysing risk-sharing

decisions. The evaluation model of contract risk-sharing performance

established in this article can be the basis for authority in its optimal risk-

sharing decision-making.

The fair and reasonable risk-sharing is helpful for smooth completion of

construction, cost saving and prevention of contractual dispute. However,

research and investigation have shown that in order to protect its own

interests, construction authority in the past often made use of exceptions to

exert most of the risks onto the contractors. Although the authority can

avoid the risk with such contract agreement that is lack of fairness, adverse

effect can possibly arise due to the over provision and cause difficulty to

undertaking personnel; moreover, it is found from many cases of arbitration

and mediation that the authority may still need to compensate the

contractor's loss due to breach for violating principle of fair and sincere

contract. In addition, the increase of contract risk is not only incapable of

stopping unworthy companies on vicious acquisition of tender, but also

strangles willingness of tendering from honest companies, which forms

the vicious circle of "bad elements driving good elements away" and

hence no protection is provided on construction quality.



Nevertheless, contractual amount and hidden risk involved in public

construction are often vast and complicated, the selection on suitable

decision making of risk-sharing is truly an important subject that is

worth for discussion at present under principle of reasonable fairness; so

that both contractual parties can bear affordable risks and thoroughly

bring out their professional skills to pursue maximum profit for the overall

construction. In view of this, the article starts with brief description on

connotation of risk-sharing decision for public construction contract. This

follows logic of decision on risk-sharing to define risk of public

construction contract and establish risk-sharing decision model, develop the

"Risk-sharing decision system for public construction contract"; moreover,

the recent risk of "escalation" that seriously affect execution of domestic

public construction is taken as example for escalation of suitable decision

model and execution on decision analysis relating to risk-sharing, which

provides reference for the authority upon selection on risk-sharing decision

and setting of contractual clauses.



CHAPTER 2

ALLOCATION OF RISK INTO CONTRACTS

There are numerous risks that are apparent in any business deal,

however, outsourcing by its nature creates additional risks that need to

be assessed and apportioned in the contract. This chapter scusses the

terms of the contract, disclaimers, subcontract provisions, privity of

contract and general issues of insurance and force majeure.

2.1 Types of risks and terms within a contract

As in any contract agreement , specification of the scope of services and

the allocation of responsibilities between the client and service provider is

essential .

An important function of the outsourcing agreement is the allocation

between the parties of the various risks associated with the

contemplated transaction. The risk allocation schema poises one of the

most difficult of issues between the customer and service provider.



There are numerous risks that are apparent in any business deal,

however, outsourcing by its nature creates additional risks that need to

be assessed and apportioned in the contract.

There are several risk categories that need to be considered as part of

the agreement and relationship. These include (but are not limited to) :

Budget Risk – Such as Funding constraints, Prioritization

uncertainty, Under funding potential

Cost Risk - including Contract price fluctuation ,excessive

consumption of resources , project overruns, unexpected

changes in rates of material and labor wages.

Technical Risk - such as failure of structure, or incomplete

transactions that disrupt operations and involve substantial

direct and indirect losses.

Schedule Risk – like productivity uncertainty, Area / Facility

availability, and adverse environmental availability

Scope - typically the most frequent source of friction after

signing the contract.



Legal and Regulatory Risks - affect not only such

regulated industries as health care and banking, but

increasingly most other businesses.

Extraordinary Risks - including the familiar circumstances

that constitute force majeure. Parties must also consider

other extraordinary risks and events, including

acquisitions and divestitures, changes in control etc.



CHAPTER 3

CONTRACT RISK MANAGEMENT

Contract Risk Management (CRM) is an enterprise-wide issue, which

directly or indirectly affects everyone in the organisation. In the final

analysis, all transactions in every organisation are based on contracts of one

type or another. Historically, despite ‘policies and procedures’, contracts are

seen as the responsibility of the legal department, and normal practice is to

abdicate contractual issue, processes and procedures to the legal department.

The consequences of this are all too evident:

Unwritten contracts (handshakes and verbal commitments)

Unsigned contracts

Missing and lost contracts

Operational activity in breach of contractual obligations

Missed events and deadlines, such as renewals and

terminations

Multiple, often contradictory, contracts with third parties

Inability of management to monitor or respond to contractual

exposures and liabilities

Over-expenditure, for example through not exploiting bulk

supply agreements, rebates & discounts



Companies with good Governance need to be sure of their contract

management and need to understand the risks inherent in their contractual

obligations. Unless the organisation has a sophisticated and dedicated

approach to contract management it can have no way of measuring this risk.

3.1 Myths and Misconceptions

In their search for solutions, organisations usually start with the idea that

they need a system that captures images of the actual hardcopy of the

document, and which then maintains a central repository from where the

images can be readily retrieved -in other words, a ‘document imaging’

system. A dilemma then arises because there is a need to identify how the

document flows through the process from creation to termination, so

(logically) the document imaging system must have workflow on top. At

this point, confusion reigns because these are two separate applications of

technology, and the search for products that will integrate these two ideas

leads the customer down many dead ends.The outcome is that the

functionality of workflow is well presented by workflow vendors, while the

‘superiority’ of a specific document imaging solution is sold in terms of

efficient storage, retrieval, indexing and scanning.

Nowhere does this line of thinking address the real functional requirements

of a system to facilitate the management of contract lifecycles and risk. All

this is seen as add-on development either by the user or by an external

development team.



3.2 The Practical Solution

Naturally, a widely accessible repository of contract information in

electronic format is desired, but it goes far beyond that. Managing contracts

responsibly means

Knowing what contracts are in place, and knowing where

they are

Knowing what contracts you have with all the business

entities within your business domain

Knowing in advance when the events on every single

contract will occur (reviews, renewals, terminations)

Knowing continuously the financial implications of all the

contracts, individually and overall

Knowing the consequences and obligations inherent in each

and all the contracts

Knowing all the business constraints which the contracts

impose on your business

Knowing when contracts become unsustainable because of

new socioeconomic and regulatory circumstances

Ensuring that every individual within the company is aware

of and

complies with all the terms and obligations of the contracts

which affect them



Knowing why the contract exists and what risks are

addressed by every contract

Knowing the risk profile of every contract and being

accountable for the overall exposure of the company to the

risks in all the contracts.

Having a clear and accurate view of the significance of each

contract and being able to categorise them in terms of ‘urgent

and important’ in the daily activities.

3.3 The Challenges of Contract Management

It becomes evident that a document imaging system with workflow doesn’t

begin to address these issues. Success still depends on the ability of the

individual managers to read through the contracts every day to extract what

has to be done. This is clearly impractical, and therefore a good deal more

automation must be introduced so that contracts ‘can speak for themselves’.



3.4 Contract Knowledge Bases

To achieve these objectives, each contract must be reviewed and the salient

points, events, dates, clauses and tasks must be recorded in an active data

store. This data store must not only deliver meaningful information in

response to enquiries, but should also ‘push’ information to the relevant

individuals whenever necessary. Scanning the contract documents is easy –

interpreting them is not. It is a manual exercise, and is very subjective.

Legal will extract legal risk; Finance will see the risks in ROI, payment

terms, cash flow and capex. The Business Continuity Manager will have

another view, as will Operations. The challenge is to make the interpretation

and management of contracts as consistent as possible, so that risks can be

compared and policies and procedures can be standardised. This doesn’t

necessarily mean introducing an automated ‘contract authoring’ system.

That in itself is a separate subject for heated debate, as it introduces many

dilemmas and control requirements.



3.5 Risk and Contracts

A framework for managing contractual risk must be defined and

implemented in policies and procedures. This must be applied to every

contract in place and new contracts must be reviewed against this

framework. A risk framework must at very least, categorise risk types,

identify and classify possible risk events, impact types, vulnerabilities and

probabilities. From this, a simple ‘exposure’ can be deduced, which, even

though it is unlikely to be accurate, does give management a vehicle for

measuring and controlling the company’s exposure. It must touch and guide

all role players, contract owners and administrators in their daily activities.

It is not a direct part of the ERP system. Instead, the ERP system must be

configured to guide operations in conforming to contractual obligations and

processes.

3.6 Interdependencies

Contracts are not discrete, freestanding documents. There is always a

structure within a company’s contractual landscape wherein contracts are



interrelated or interdependent. A particularly visible instance of this is seen

in the area of Property Leases. The lease must

govern the services contracts for the premises, because they should all have

synchronised ‘termination’ clauses. Furthermore, contracts that depend on

other contracts ‘inherit’ the risk profiles of the associated contract, and this

makes management even more complex.

3.7 Positioning Contract Management solutions

The true context of contracts is based on the premise that a business

interacts with others to exchange goods and cash. This exchange process

creates a contractual relationship, regardless of the depth or clarity to which

that relationship is negotiated. The idea of ‘never signing contracts’ is a

fallacy –obligations and liabilities arise anyway.

The reality is that contractual relationships are ingrained in the very fabric

of the enterprise. Therefore, Contract Management must be deployed ‘from

the top, down’ as an instrument to ensure good Governance, Compliance

and Risk Management throughout the organisation.



CHAPTER 4

Managing RISK in Contracts

The logic expressed by the general contractors is that risk should be

allocated to the party that is in the best position to manage it. In reality, it

frequently happens that the party with the strongest bargaining position gets

to allocate the risk in a contract.

Let’s take a look at some of the most common mechanisms general

contractors will employ in this risk allocation process:

Indemnification clauses

Additional insured requirements

No damage for delay clauses

Pay-if/when-paid clauses

4.1 Indemnification Clauses

One of the most common risk allocation devices utilized by “upstream”

parties in the construction contract is the indemnification/hold harmless

agreement. Indemnification may be simply described as the obligation of



one party (the indemnitor) to reimburse a second party (the indemnitee) for

the losses that second party incurs, or the damages for which it may be held

liable.

In the construction context, indemnification clauses are used to shift risk

from upstream parties to subcontractors. Through contractual provisions the

subcontractor is often required to indemnify not only the general contractor

and the owner, but also the architect and the engineers.

Indemnification clauses are used to transfer liability for damages and/or

judgments, transfer the duty to defend, and transfer or allocate the duty to

insure. The indemnification clause is usually found in its own section of the

contract.

Today, most states designate, by statute or judicial ruling, the types of

liability that can be transferred contractually and the type of language

required for such transfers to be enforceable.

The modern indemnification provisions can be grouped into three different

categories: broad form, intermediate form, and limited form.



4.1.1 Broad form indemnification clauses

The broad form (also called no fault) indemnification clause requires the

subcontractor to assume any and all liability for the project regardless of

fault, even if the liability arises from the sole negligence of another. Since

this type of clause shifts the entire risk of loss, the subcontractor who agrees

to this provision absorbs massive amounts of liability for the project. Today,

most states either prohibit broad form indemnification clauses by statute, or

simply refuse to judicially enforce these agreements.

4.1.2 Intermediate form indemnification clauses

With this type of clause, the subcontractor is required to assume all liability

for the project except that which is due to the sole negligence/fault of the

indemnitee. Under the intermediate form, the subcontractor will have to

indemnify from all liability and damages, so long as it does not arise from

the sole fault of the general contractor, the owner, or anyone else the

subcontractor has agreed to indemnify.

This type of indemnity imposes on the subcontractor liability for its sole

negligence, as well as for the joint negligence of itself and the indemnitee,



without regard to the indemnitee’s proportion of fault. Therefore, a

subcontractor can find itself responsible for all liability resulting from an

accident in which the general contractor was 99% at fault. This type of

indemnification poses the same problem that broad form indemnification

creates; having a subcontractor with a relatively low financial net worth

taking on the financial risks of the large general contractor and owner.

Even though this intermediate form does not allow for zero fault

indemnification, it offers only a modicum of protection more than the broad

form and should be avoided if possible by a subcontractor.

Today, several states ban these types of clauses in at least some contexts.

However, 18 states ban only broad form clauses.

4.1.3 Limited form indemnification clauses

Limited form indemnification clauses are the least stringent on the

subcontractor. Limited form indemnification is the basic concept of

comparative fault. Under this form, the subcontractor assumes liability only

to the extent of its own negligence or fault.

This form of indemnity is simply a restatement of the common law principle

that an entity should be held liable for only those circumstances over which



it exercises control. In order to control risk and limit potential liability, all

subcontractors should try to ensure that any contract entered into contains

only a limited form indemnification agreement.

4.2 Additional Insured Requirements

Additional insured requirements are often used to reinforce indemnification

agreements, and in some cases to circumvent anti-indemnity statutes.

Construction contracts typically require all general contractors and

subcontractors to carry a certain amount of liability insurance to pay any

defense costs, settlements, or judgments arising out of claims related to that

contractor’s work. The named insured is the person or business to which the

commercial general liability policy is issued, and also is the one who pays

the premiums and deductibles, has the power to cancel the policy, and

receives any notice of cancellation.

With the rise of anti-indemnity statutes, it has become a common risk

management technique in the construction industry for the general

contractor to require the subcontractor to grant both the general contractor

and the owner additional insured status on the subcontractor’s commercial

general liability (CGL) policy.



The effect of the additional insured status is similar to the effect achieved by

an indemnification agreement. Essentially, the general contractor obtains a

direct contractual relationship with the subcontractor’s insurance carrier, but

is under no obligation to pay either the policy premium or deductibles.

There are several reasons general contractors require subcontractors to grant

them additional insured status.

General contractors require subcontractors to name the GC as additional

insured in order to protect the GC’s own insurance policies. A general

contractor would generally prefer not to use its own insurance to defend a

claim, when another option is available.

Many jurisdictions have held that by tendering its defence to the

subcontractor’s insurer, the general contractor keeps its own insurance

company out of the suit. If the general contractor uses the subcontractor’s

carrier for defense and does not seek indemnification from its own insurer,

the subcontractor’s carrier cannot sue the general contractor’s insurer for

reimbursement of any money paid out on the general contractor’s behalf.

Therefore, the general contractor’s premiums will not increase and no

deductibles will need to be paid.

Furthermore, a carrier has no right of subrogation against an insured. Thus,

additional insured status prevents the subcontractor’s insurer from bringing



suit against the general contractor for damages, even if the general

contractor caused the loss.

Additional insured status can also be used to circumvent anti-indemnity

statutes, since many ant indemnity statues make exceptions for insurance

contracts. Using additional insured status, a general contractor can shift the

burden of liability to the subcontractor just as in broad form or intermediate

form indemnification; yet not have the provision be declared void as against

public policy. In addition to the requirement that the subcontractor include

the owner and contractor as additional insured on its CGL policy, there will

likely also be a provision containing a waiver of subrogation. This is a

contractual term that waives a subcontractor’s rights of subrogation for loss

payments and expenses made by the subcontractor or covered by the

subcontractor’s general liability insurance.

4.3 No Damage for Delay Clauses

Construction owners are increasingly placing “no damage for delay” clauses

in their contracts, and general contractors are in turn including similar terms

in their subcontracts. These clauses provide that the contractor will be

entitled to an extension of time for delays, but no additional compensation

to the subcontractor is required.



The no damage for delay clause is utilized to protect the owner and general

contractor from liability for unanticipated additional costs associated with

delay to, disruption of, or interference with the subcontractor’s work. Many

construction delays result from the acts and omissions of the owners, its

design professionals, or the general contractor. These delays result in higher

overhead and construction costs which impose a significant financial burden

upon subcontractors.

The treatment of no damage for delay clauses is varied among the states.

Some states have declared that for both private and public contracts clauses

which disallow remedy for delay caused by the owner or contractor are void

as being against public policy. Other states have declared that no damage for

delay clauses are only void when incorporated into a public contract. Some

jurisdictions have allowed these clauses to be enforced in both public and

private contracts, but there are numerous exceptions to that enforcement.

And yet other states enforce no damage for delay clauses as written, but

strictly construe them against those seeking their benefit.

Be aware of the local law, and review the construction contract to make sure

that it does not require you to waive your rights to remedies for costs

associated with delays in construction caused by the general contractor or

owner.



4.4 Pay If/When Paid Clauses

Time of payment clauses are generally considered either pay-if-paid or pay-

when-paid. In the majority of jurisdictions, these clauses will generally be

construed as pay-when-paid clauses and therefore serve only to determine

the time of payment. A pay-when-paid clause is the standard provision and

will be found in most construction contracts. However, pay-if-paid or

contingent payment provisions have become increasingly popular with

general contractors, so you should carefully scrutinize all payment

provisions.

A pay-if-paid clause actually shifts the risk of owner insolvency from the

general contractor onto the subcontractor. A true pay-if-paid clause places a

subcontractor in the position of working on a contingency basis, where the

subcontractor only gets paid for the work performed if the owner makes

payment.

These types of clauses place a subcontractor at risk for non-payment by the

owner for reasons created by the general contractor and/or other

subcontractors.

Therefore, you should be ever vigilant as to the specific wording of the

payment provisions of contracts, so as to ensure that they have not without

knowing absorbed the risk of owner insolvency.



Risks may indeed be an unavoidable part of life, but when it comes to the

contracts your company signs, there are ways to minimize them. Read

contracts carefully, and know your state’s laws. If in doubt, get matters

clarified in writing. Be on your toes, and do your homework upfront,

because after a contract is signed isn’t the time to realize it has unfavourable

provisions.



CHAPTER 5

Escalation – Meaning and Scope

The term Escalation means an increase that counteracts an unjust

discrepancy between the price of a product and the cost of material. It is the

provision of "the adjustment of prices proportionally and usually

periodically and automatically to an alteration (as a rise) in the cost of

materials, or a similar adjustment of wages to an alteration in the cost of

living"1.\ In a works contract, it would mean an increase in the price of an

item of work over and above rate stipulated in the tender, during the period

of the contract and according to the escalation clauses as well as the

formulae therein.

The basic rationale for the price escalation clause is to compensate a

contractor for increase in construction cost during the contract period. It is

difficult, however, to determine precisely the quantum of actual increase in

cost as construction activities are multifarious in nature and involve many

parties, materials and equipments. This difficulty is sought to be overcome

by resort to a “Formula” approach which has the additional advantage of

simplicity and obviation of the necessity to audit actual costs/Separate

formulae can be derived to represent the elements of increase in cost of

labour, materials and other commodities used in construction .The



fluctuation in their costs can be related to appropriate indices compiled by

various “approved” agencies.

Wage structure of labour has been moving upward continuously.

The Minimum Wages Act, 1948 was made applicable to employments in

“Building and Construction and Maintenance of Roads”. Though not

specifically applicable to the river valley projects, it is nevertheless deemed

as extended to them as well. Fair wages have been prescribed by the

competent authority for various areai under its jurisdiction in the State of

Andhra Pradesh. In the States of Bihar, Gujarat, Kerala, Tamil Nadu and

West Bengal, the minimum wages have been linked to the consumer price

indices and, therefore, vary from month to month. In other states, however,

the wages remain static till revised through a gazette notification by the

State Governments concerned. Normally this is done biannually. Apart from

the minimum wages, labour wages are subject to supply and demand

syndrome. Many large project sites become supplier's markets particularly

in respect of skilled and semiskilled workers. Wages get pushed up far

above the minimum prescribed.

The principle that the contractor needs to be compensated for

"Increase in costs over the tendered prices due to increase in labour wages,

cost of POL and other materials are now fully accepted. Different

government organisations, however, adopted varying formulae and linked

them with the whole sale price.



Index, Consumer Price Index, Cost of Petrol/Diesel etc. compiled

and published by the Government periodically. As the number of projects

financed by the World Bank increased, model tender documents based on

International Competitive Bidding (ICB) or Local Competitive Bidding

(LCB) procedures were compiled by the Government and suggested for

adoption in the various World Bank assisted projects in the country. The

World Bank lender documents provide for compensating contractors for

increases in the prices of materials, labour and POL over and above those

stipulated in base period. Separate provisions arc made for escalation in

foreign exchange and local components of costs. Freezing the rate of

exchange of foreign currency is also provided these days.

The operating overheads and profit margin of contractors as well as

the basic construction materials supplied by the client are excluded in

calculating escalation by applying a suitable factor in the escalation

formulae. Some contract documents exclude works of small value or of

shorter durations or a specified initial period from the application of

escalation clauses contained herein.

The international practice is mainly based on the conditions of

contract for works of civil engineering construction stipulated by the

Federation Internationale Des Ingenicurs Conseils (FIDIC). The fourth

edition of the FIDIC Conditions of Contract (1987) contains three

alternative provisions for dealing with escalation (price adjustment). In the



first alternative, the contract being of short duration no price adjustment is

suggested. In the second alternative, price adjustment is suggested

establishing the difference in costs between the basic price and the current

prices of local labour and "specified In the third alternative, price

adjustments are the application of indices in a formula.

The issue that may be raised here is that though the principle of full

compensation for additional costs (compared to the base period) incurred

because of the increase in rates and prices of various inputs is accepted by

the client and the World Bank, incurred because of the intent of the

principle, and therefore, it needs to be reviewed. The following

specific instances may be noted in this regards

i. Only 75 percent of the work done is considered eligible for

escalation under the formula. The cost of “Overheads” at 15

per cent and “Profits” at 10 per cent is presumably taken as

ineligible. If overheads arc a cash cost in this industry, and

inflation erodes profits, could these be excluded from the

scope of escalation.

ii. The works contract grants various types of advances to

contractors. But the percentage component of the advances

(PA) taken is excluded for purpose of escalation in the

formula. As it is contrary to the intent of the provision of

granting advances; could this also be considered.



iii. The cost of departmentally issued materials – cement steel

etc. is deducted from the value of work done. It is argued that

these material process and therefore may not be excluded for

calculating escalation on labour and fuel.

iv. The rate of escalation is calculated by linking it with the

Wholesale Price Index (WPI), the Consumer Price Index

(CPI) and the price of diesel only for POL. There is a

standing debate in the country that WPI and CPI do not truly

reflect the price variations in any specific industry including

the construction, its materials and wages of construction

labour.

Further, diesel price is no index of the variations in the price of

lubricants. Consequently, different and specially constructed indices

should be considered in order to reflect the situation more accurately in civil

works projects.

All these and related issues need detailed examination. Timely

completion of projects is the common goal of all those involved in the

construction process. Therefore, the relations between the parties should be

based on mutual confidence, trust, equals and equity. The problems arising in

the course of project execution could be settled through mutual discussions

and consensus. In any event, the costs of payment of escalation



are much less than those suffered due to project delays and cost

overruns.

5.1 ESCALATION FORMULAE

The total cost of a civil works project, based on the rates quoted in the

accepted tender, comprises the following five components:

Materials and POL delivered at site.

Manpower employed for carrying out operations

necessary to comple te the con t rac t .

Operation of machinery, plant and tools

Contractor's overheads and supervision

Contractor's profits

Each component includes numerous items whose costs

may fluctuate over time. For computing escalation on a component, the

cos t var ia t ion of a l l o f i t s cons t i tuen t i t ems i s s tud ied ,

customari ly every quar ter . Whereas a few smal l volume or

old time contracts may still resort to a study of rate variations for

escalation, the trend everywhere is to follow the “Formula” approach

adopted by the World Bank assisted projects.



The Formulae fo r ESCALATION

a. Materials VM = 0.75 x PM x R l (Mi - Mo)

100 Mo

b. Labour VL = 0.75 x PL x R1 (Li - Lo)

100 L0

c. POL VF = 0.75 x PF x R1 (Fi - Fo)

100 Fo

The main features of the above formulae are the following:

i. Only 75 percent of the total value of work done is eligible for

calculating escalation.

ii. The value of work done eligible for escalation is considered as

value of work done in the quarter minus the cost of materials

supplied by the client and consumed in the quarter , minus

proportionate advances from the value of work done during the

quarter (PA).

iii. The respective percentage for material (PM), Labour (PL) and

fuel and lubricants (PF) might vary depending upon the nature of

the work.



iv. The stipulated index for materials (Mi, Mo) is the whole sale

price index for all commodities published by the reserve bank of

India.

v. The stipulated index for labour (Li, Lo) is the average consumer

price index for industrial workers in different industrial centres

as published by the labour bureau , Ministry of labour.

vi. The stipulated index for fuel and lubricants (Fi, Fo) is the retail

price of diesel at a specified retail outlet in the vicinity of the

project.

5.2 How to Use the Consumer Price Index for Escalation

The Consumer Price Index (CPI) measures the average change in the prices

paid for a market basket of goods and services. These items are purchased

for consumption by the two groups covered by the index: All Urban

Consumers (CPI-U) and Urban Wage Earners and Clerical Workers, (CPI-

W).

Escalation agreements often use the CPI—the most widely used measure of

price change—to adjust payments for changes in prices. The most

frequently used escalation applications are in private sector collective

bargaining agreements, rental contracts, insurance policies with automatic

inflation protection, and alimony and child support payments.



The following are general guidelines to consider when developing an

escalation agreement using the CPI:

DEFINE clearly the base payment (rent, wage rate, alimony, child support,

or other value) that is subject to escalation.

IDENTIFY precisely which CPI index series will be used to escalate the

base payment. This should include: The population coverage (CPI-U or

CPI-W), area coverage (India City Average, West Region etc.), series title

(all items, rent of primary residence, etc.), and index base period (1982-

84=100).

SPECIFY a reference period from which changes in the CPI will be

measured. This is usually a single month (the CPI does not correspond to a

specific day or week of the month) or an annual average. There is about a 2-

week lag from the reference month to the date on which the index is

released (e.g., the CPI for May is released in mid-June).

STATE the frequency of adjustment. Adjustments are usually made at fixed

time intervals, such as quarterly, semiannually, or, most often, annually.

DETERMINE the formula for the adjustment calculation. Usually the

change in payments is directly proportional to the percent change in the CPI

index between two specified time periods. Consider whether to make an

allowance for a "cap" that places an upper limit to the increase in wages,



rents, etc., or a "floor" that promises a minimum increase regardless of the

percent change (up or down) in the CPI.

PROVIDE a built-in method for handling situations that may arise because

of major CPI revisions or changes in the CPI index base period. The Bureau

always provides timely notification of upcoming revisions or changes in the

index base.



6. CONCLUSION

This literature will help in understanding the Risk inherent in Contracts and

implementing robust contractual risk management process. By referring to

this literature and following logic of risk-analysis and Escalation

calculation, the Allocation of Risk in Construction contract has been

evaluated and implied. Any kind of risk arises from the contractual clauses

and claims has been enumerated. The escalation clause has been discussed

in detailed and the calculation of escalation on construction material has

been calculated with the help of Consumer Price Index. This is an overall

work related to Risk Analysis and Management in Contracts and Escalation

related with it.



REFERENCES :

1. http://www.bls.gov/cpi/cpi1998d.htm

2.


http://www.bls.gov/cpi/cpi1998d.htm


Contractor not entitled for any claim on account of variations in many a

case:

Eg: Clause 11.(a)-Probable distribution of various items of

internal/external services are indicated on drawings. These are tentative and

may be varied wherever necessary at the discretion of the Engineer-in-

Charge. The Contractor shall not be entitled for any claim on account of any

such variation.

(b)-Layout of the building indicated in the site plan is tentative. No

adjustment in price shall be done on account of final approved layout within

the site plan area.

Security Deposit- Government shall not be responsible for any loss of

securities or for any depreciation in the value of securities while in their

charge nor for loss of interest thereon.

Re-imbursement/refund on variation in price-Provided, however, no re-

imbursement shall be made if the increase is not more than 10% of the said

prices/wages and if so, the re-imbursements shall be made only on the

excess over 10% and provided further that any such increase shall not be

payable if such increase has become operative after the contract or extended

date of completion of the work in question.

Minimum Wages payable-The Contractor shall have no claim whatsoever,

if on account of local factors and/or regulations, he is required to pay the



wages in excess of minimum wages as described above during the execution

of work.

According to the General Conditions speaking about the schedule of

payments, 1,50,000 or 1% of the remaining amount after the payment of

Advances on Account whichever is greater shall be held by the client as the

retention money.

The above are few clauses observed from the contract which provide no

claim for the Contractor on account of any variation in price.

No reimbursement on the variation pertaining to plant and machinery is

provided.

Reimbursement/Refund on variation in Prices of fuel:

EP= (KP X VG1) (F1-F0)

100 F0

Where,F1 = Wholesale Price Index for the sub group for fuel, power, light

and lubricants published by Economic Adviser to Government of India as

on the date of commencement of the period of reckoning.

This provision does not suffice the Contractor’s expenses on fuel since it is

based on WPI and does not take into consideration the local prices. This

may lead to client’s advantage during calculation of escalation.



The Contractor keeping in view such factors as mentioned above tends to

quote a higher price to cover the contingencies and overheads and the

additional expenses for which he is not entitled for any compensation.

On the observing the General Summary of the Tender we find a vast

variation in the quoted prices of the client and the contractor wherein the

price quoted by the Contractor is on a very high side which may be due to

the effect of the one-sided nature of the Contractual clauses.

The Contract as a whole provides no provision of claim for the Contractor in

the event of any variation. Consequently the Contractor tends to quote a

very high price for the work keeping in view all the potential risks arising

due to variations hence leading the Client into heavy expenses.


Contract Risk Assessment

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