Contractual Risks of SME Contractors: A Case Study of Mechanical and Electrical Contractor

Before starting any construction project, at least two parties or companies have to prepare or design a contract based on the agreement between them. Once they agreed on each clause in the contract, they will officially enter the contract ruled by laws and other relevant construction regulations.

In Vietnam, all parties working in construction shall sign contracts complying with current laws and rules, Government’s decrees, Ministries’ circulars and local authorities’ regulations. For Foreign Direct Investment (FDI), there are many rules and regulations for them to follow.

By studying the case of a specific project in an FDI investment in Ho Chi Minh City, it was found out that many contractual risks had faced by the SME contractor and obviously taken a serious loss of profit at last.

These risks include: site inspection and work measurement; quantity acceptance and payment certificates; project delays; work omissions by the owner; and payments from the owner.
Mr. Vo Quoc Vinh made a research which objectives were to: (1) identify the risks of a construction contract; (2) verify the causation of contractual risks; and (3) propose possible solutions to protect SME Contractors from uncertain contractual risks.

Conclusion

Contractual risks were found in the contract between two parties or more. Lack of contract review before entering into it would be a failure of a party. Project failure means that the project has failed to meet its cost, schedule and technical performance objectives, or it does not fit in the organization’s future (Cleland and Ireland, 2007:365).

In this report and other similar cases, SME contractors have often taken such risks when dealing with the owner or main contractor whose sizes of business are always larger and stronger in many fields.

That result of project failure came from the way people actively take the chance to prepare, design and compose the contract documents. Instead, SME contractors tend to avoid or ignore the opportunities of transferring the risks by the work of contract design. Moreover, the level of professional policy and working manners in SME contractors cannot compare to big companies, especially the knowledge and experience in legal issues.

The report can be a useful tool for SME contractors in dealing with problematic clauses in similar construction projects in some ways, such as the implementation of current laws, rules and other regulation; systematic frameworks from contract literature reviews; international institutes of contract forms like FIDIC or the organizations of AGC, ASA and ASC or The ICE Conditions of Contract.

The report also raised the way which Lessons Learned documents should be organized to review the good and the bad activities in the project and encourage to be used for future projects in terms of reduction of the same problems in construction contracts.

Last but not least, the report also recommended SME contractors to apply the latest version of ISO 9001 in their businesses for a better quality performance in a rapid competitive market. Invest now, take later!

Recommendations

It is recommended that contractors should avoid or reduce the same type of problems in future projects by applying these approaches as follows:

Post-Project Reviews - offer insight into the success or failure of a particular project as well as a composite of lessons learned from a review of all the projects in the organization’s portfolio of capital projects (Cleland and Ireland, 2007:327-328).

Site Inspection - to maintain smooth operations and the quality of site inspection in construction stage and avoid unforced conflicts from this trade; owner should employ qualified, experienced technical staff. Good coordination and cooperation between project teams are needed.

Project Delays - After being awarded the contract, contractor must prepare and submit a proposed construction schedule for the review and approval of the project owner.

Omissions by Owner

Contingency Cost - To protect from financial loss in a project for any non-prevented reasons, it is important to estimate contingency costs and add them into the tender. These costs are usually expressed as percentage of direct costs or as a specific amount of money in the tender. Mullin and Kantor (1994) compared that “contingency allowances are much like insurance”. Along with contingency cost, hidden costs should be recognized and added to the estimation for bidding. Borg and Borg (1994) advised contractors to examine carefully the general conditions of the contract and visit the site, so as to have a full knowledge of all the possible hidden costs.

Concept of “Unexpected” and “Equitable Price Adjustment” - normally, the specifications give the owner the right to make changes in scope, with specific compensation to the contractor (Borg and Borg, 1994:17-35).

In order to avoid any dispute or different interpretations on this matter, the authors suggested establishing “a formula for pricing changed work” in the contract.

Risk Transfer - “The form of the contract plays a significant role in the respondents’ perception of risk” and “Transferring the responsibilities for the construction documents to another party also transfers the risk” Simu (2006).

Payment Delays - payments from the project owners are considered a vital source of any contractors in construction industry. Late payment will definitely damage contractor’s cash flow in the book of account receivables. Once periodic payment certificates are prepared, properly signed, and forwarded to the owner, prompt payment should be made (ASCE Manual, 1988:145).

Application of ISO 9001 in Quality Management - it is very useful for SME contractors to apply the latest version of ISO 9001 (partial or the whole regulations) to manage their businesses as well as the construction projects in a professional, effective method. This kind of quality control system will need time, effort and some budget to apply ISO in construction but contractors will save a lot and reserve their planned budget.

His thesis abstract is copied and posted.

Abstract

This report reviews the theory of contractual risks in terms of project delays with no compensation, delays in payment with no penalty, work changes by the Client, delays in site inspection and acceptance for quantity of work done, omissions by the Client from the signed contract, and so on.

From a detailed literature review, the report explores major risks that SME Contractors often face during the construction stage throughout a case study. The collected information from the case reflects the hypothesis that the Client has used an unfair treatment to the Contractor by the application of the Contract – obviously prepared by the Client.

The report also suggests some recommendations to minimize the risks from the construction contract in the stake of SME Contractors. These suggestions will somehow help them control the benefits from the protection of losses in the implementation of the contracts. On the other hand, the report asks for a fair treatment from the owners of projects in term of win-win negotiation in the contract preparation by using the theory of FIDIC, ICE Conditions of Contract and other useful, reliable sources.

Hopefully, this report will show the contribution to a better environment of risk reduction in the construction contracts from its findings, analysis and recommendations. It is studied especially for the legal support to SME Contractors in construction industry in Vietnam.