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Management of Construction Contracts

Check List No. 5 – Certificate of Non-Completion

by Gursharan Singh

1.0 Introduction

1.1 The completion period of any construction contract is a vital aspect of its effective and cost-efficient management. Thus it is important that delays are kept to a minimum. The authorized delays that are attributable to the client and those beyond the control of the contractor are covered by the issue of an extension referred to as Extension of Time. This aspect has been explained in detail in Check List No.4. However, delays that are attributable to the contractor including sub-contractor/sub-suppliers are subject of imposition of financial penalties.

2.0 Objective

2.1 All standard construction contracts documentation provide relevant terms and conditions to provide authority for imposition and rate of penalties for delays caused by the contractor. The period subject to penalties would be beyond the original completion period and any approved extensions of time that are approved by the client. This is of particular importance where the standardized contract documents are not to be used but new formats are to be prepared. Clients should ensure that the relevant terms and conditions are provided in the contract documents. The objective is to emphasis the importance of the many aspects that are relevant to the imposition of penalties and to effect their enforcement in the courts of law.

3.0 Liquidated & Ascertained Damages [‘L&AD’] [or Penalties] imposed for Delays

3.1 Costs associated with delays that are attributable to the contractors/suppliers would be borne by the responsible contractors/suppliers who may be penalized with the imposition of ‘L&AD’ at rates as prescribed in the terms of the contract. It is particularly important that the computation of the ‘L&AD’ rate that is to be incorporated in the contractual documents is computed realistically. The ‘L&AD’ rate must be computed to be reasonable to cover the additional costs that may be suffered by the client or to compensate for revenue that may be lost arising from the delays.

3.2 The ‘L&AD’ computed rate should not be too low as to not to have little if any, effect on the contractor on the commitment and seriousness of the contractor and other implementation parties to ensure completion of the works within the prescribed completion period. Similarly the ‘L&AD’ rate should not be too high as this can result in the contractor seeking legal remedy [courts of law or arbitration] to have the ‘L&AD’ rate to be reduced on the grounds that the rate is unfair as it could provide profit to the client. The fact that the contractor was aware of the ‘L&AD’ rate and would had included the possible risk in pricing his bid sum the high rate may generally be ignored by the relevant legal authorities. Consequently the client would be on the losing end in both cases as he would have paid a high rate for the risk in the event the works are completed within the approved completion period and again not being able to claim the prescribed rates in the event ‘L&AD’ is imposed.   

4.0 Contents

4.1 The aspects that should be of importance to the professionals involved in any construction contract management are listed below. However, these should be modified as appropriate to the scope of works of the specific contract.   

[a] Prepare ‘Summary of Incomplete Works’ with Brief Description

[b] Complete with Relevant Documents [to be summarized and attached as  an

     Appendix] 

[c] L. & A. D [or Penalty] Rates to be in Terms that is similar to those prescribed

     in the contract terms and conditions;

[d] Certificate of Non-Completion to be signed by [Authorized] S.O. only

[e] Relevant correspondence copies regarding the contractor’s poor and

     unsatisfactory performance, together with the signed Certificate of

     Non-Completion, to be forwarded to the Relevant Bank and Ins. Co.

5.0 Responsibilities of Client where a ‘Certificate of Non-Completion’ is issued.

      [Including his appointed representatives - S.O./Tech Professionals]

5.1 The client should ensure that

[a] Certificate of Non-Completion is issued promptly and to be effective from the date of expiry

     of the approved completion period;

[b] The Certificate of Non-Completion is issued in strict compliance with the provisions of the

      contract terms and conditions and by authorized persons only;

[c] ‘L&AD’ claims are claimable under the relevant contract conditions;

[d] ‘L&AD’ Claims are computed correctly in accordance with prescribed rates;

[e] ‘L&AD’ claims are deducted from interim/progress payments and incorporated in the final

      contract sum;

[f] The relevant financial institutions [banks/insurance] and others as applicable, are informed in

      advance or as required.

5.2 In some cases the technical professionals may be of the view that the contractor may not be able to complete the works. It is their responsibility to advise the client of the option of terminating the contracted works. In such an event the professionals should provide a report detailing the financial and legal implications of the termination as it would be necessary to measure the value of incomplete works. It would then be necessary to repeat the tender award process and re-award the works to anther contractor. The process would be time consuming and high financial/legal implications for both parties. Thus it is in the interest of both parties to co-operate and assist each other to complete the works without termination of contract. Thus termination should be the last option for all parties concerned.                                                                           

6.0 Responsibilities of Financial Professionals of Clients and Contractors/Suppliers

6.1 The financial/accounting professionals of both the clients and contractors/suppliers should not accept the quantum of ‘L&AD’ as recommended by the technical professionals. They should independently scrutinize the basis and methodology of computation of the claims. They should seek the advice and clarifications from technical professionals and also seek external advice if necessary where any aspect is not understood. It should be their responsibility to independently examine the basis and computations of the ‘L &AD’ claims together with scrutiny of the original supporting documents that form the basis of the computation.

7.0 Accounting of the ‘L&AD’ Amounts

7.1 Accounting professionals should account the quantum of the claims in the relevant accounts of their respective organizations and the auditors undertake an audit as planned or during in-depth audit of any selected contract. It is appropriate that the ‘L&AD’ claim amount be classified in the financial statements and accounted under ‘Revenue’. It should not used to offset the contract costs and reflect the reduced amount of the constructed works. However some accounting professionals may not have different views.

7.2 The audit professionals [internal/external] of the clients and contractors/suppliers should ensure that the technical and technical professionals comply with the prescribed procedures. In addition the auditors should also subject ‘L&AD’ to in-depth audit during audit of selected construction/procurement contracts..

8.0 Custody and Retention Period of Documents  

8.1 All relevant documents pertaining to the imposition of ‘L&AD’ should be retained in safe custody and properly indexed and for period that should include the prescribed defects liability period or statutory period or until such time when all outstanding matters have been settled, whichever is longer. The format should be in printed form and computerized form. Clients/Contractors/Suppliers should obtain relevant expertise including legal advice in respect of documents maintained in computerized form.   

9.0 Predetermined Completion Period Implications

9.1 The completion period of any contract can either be predetermined [or fixed] in advance by the client or it could be stated by the prospective contractors in their bids. The predetermined completion period is comparatively very much shorter than that would normally be required under normal construction periods. This predetermined period is used only in exception cases where the client is convinced that all the relevant information is available regarding the scope of works and will not be subject to any delays. Thus the financial implications [cost] of a contract with a predetermined completion period are generally substantially higher due the need for additional manpower and logistical resources that would be needed for short periods.                                                  

9.2 The client generally will prescribe very high liquidated & damages rate [L & A D] for any delays. The object is to emphasize to the prospective contractors/suppliers the importance of the short predetermined period. The consequence of this is that contractors/suppliers will tend to over price their bids to take into consideration any contingent risks costs.

10.0 CONCLUSION

10.1 The Certificate of Non-Completion and the subsequent imposition of ‘L&AD’ would have financial implications that generally include additional costs. The recommendations in respect of issue of Certificate of Non-Completion and imposition of ‘L&AD’ are another aspect in the construction industry that is susceptible to fraudulent practices. The risks will increase with the quantum of contract values and the high rate of ‘L&AD’. Thus it is emphasized again that the clients should ensure that the ‘L&AD’ rates that are prescribed are commensurate with the cost of delays for the high cost contracts. Finally the relevant documents should be in safe custody until such time when all outstanding issues have been settled and legal obligations satisfied.

10.2 It is to be expected that the contractors would normally contest the issue of Certificate of Non-Completion and the consequent imposition of ‘L&AD’. The lawyers of the contractors would attempt to question the justification of the Certificate of Non-Completion and the basis and quanta of the penalties imposed and look for legal loopholes and technical defects in the documentation. Thus it is of utmost importance that the client ensures that he complies with not only the spirit but also the letter of the law, if he is to succeed in his action against the contractor.

Finally, the cost of any legal action vis-à-vis quantum of penalties should be analyzed where it is considered.  

10.3 It is in everyone’s interest if the technical professionals of all parties ensure that their efforts and recommendations are based on the objective that delays avoided and where unavoidable, the duration is minimal to ensure minimizing the ‘L&AD’ penalty quantum as it would be of benefit to their respective clients.  

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Readers - Please note that the contents of this article are for general information. No reference is made to any specific contract terms and conditions in respect to ‘Certificate of Non-Completion’ and its financial/other implications as these would vary in the contract formats, from country to country, site and the scope of works. Reference should be made to the specific clauses.

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Note: It is important that Companies involved in the Construction Industry be aware of the various contract documents that would assist in the effective management of the contracts from the inception stage to the stage when the works are completed and used for their intended purpose. The documents relevant to the various aspects would vary but they may be summarized under the following headings:

1. Tender/Tender Table Documents                  2. Contract Document Proper

3. Variation Orders                                           4. Extension of Time

5. Certificate of Non-Completion                      6. Statement of Practical Completion

7. Statement of Final Account

Articles on following Check Lists have been published in the ‘AuditNet’ Newsletters.

[a] Check List No. 4 -  Extension of Time [Delays] - October 2005 [Pending]

[b] Check List No. 3 - Variation [Change] Order - June 2005

[c] Check List No. 2 - Contract Document Proper - July 2005

[d] Check List No. 1 - Tender/Tender Table Documents - September 2005

[e] Introductory Article – Construction Management Check Lists – July 2004

 E-mail address: >gursharan38@gmail.com<>sharwant38@yahoo.com.

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GSK/Oct 05

GURSHARAN SINGH C.M.I.I.A.
[Trainer – Audit Officer]
116 Jln Hujan Manik, O.U.G. Jln Kelang 58200 Kuala Lumpur, Malaysia, Malaysia
Tel. No. [H] 603-79824492 [H/P] 019-2927178

The writer welcomes comments from readers with the intention of mutual enhancement of knowledge.

E-mail: gursharan38@gmail.com: >sharwant38@yahoo.com< >gsk38@hotmail.com<

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