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Management of Construction Contracts
[Terminology of clauses, terms & conditions]
Letter of award - Right of Acceptance
[Fraud, ignorance or mismanagement]
1.0 INTRODUCTION
1.1 Terms and Conditions in any Contract/Agreement normally have either legal and/or financial implications. It is important for auditors that they scrutinize the ‘Terminology’ of the various clauses on a regular basis. The dangers of not giving due attention to these terms is conditions can have serious financial implications to the client. The terminology of Letter of Award/or Acceptance [‘L.O.A.’] issued by a Construction Company [‘Client’] to a Quarry Owner [‘Contractor’] for the Supply & Delivery of Ballast [‘Supplies’] is being detailed below to illustrate the situation.
2.0 ‘L.O.A.’ CONDITION
2.1 A ‘Client issued to a ‘Contractor’ a ‘L.O.A.’ that included the following clause that was attached to it as one of the conditions:
‘This Letter of Award is issued to you in duplicate. Kindly acknowledge your receipt of this Letter of Award & Acceptance of the Terms and Conditions stipulated therein by returning the duplicate and third copy duly signed and witnessed within [7] days from the date of issuance of this letter. Otherwise, this Letter of Award & Acceptance shall be considered null & void.’
2.2 The ‘L O A’ was issued on 23 October 2002 but the above prescribed condition had not been complied with as the ‘Contractor’ had not accepted by the stipulated date of acceptance that is 30 October 2002. Consequently, the ‘LOA’ could be considered to have become null and void on 31 October 2002, as the prescribed condition that had stated that ‘otherwise this Letter of Award shall be considered null & void’ would have taken effect on 31 October 2002.
2.3 However, the ‘Client’ was in urgent need of the ballast for its highway project and due to shortage of acceptable ballast suppliers the ‘Client’ had no option but to approach the same ‘Contractor’ again. The ‘Contractor’ realizing his strong position and the weakness of the ‘Client’ proposed certain changes to the earlier Terms and Conditions in the L O A dated 23 October 2002. The changes proposed for the payment of an ‘Advance Payment’ [USD3.0m] that was 15% of the estimated value of the contract [USD20.0m] for total estimated quantity of ballast supply and also revision of supply and delivery rates for the ballast to the stockpile sites whereby the new rates were 20% higher than the earlier quoted rates. The ‘Client’ agreed to the new proposals at a meeting that was held on 3 November 2002 and issued a new ‘LOA’ immediately on 4 November 2002. The ‘Contractor’ accepted the ‘LOA’ that incorporated the new conditions and returned it to the ‘Client’ on the same date.
3.0 CONCLUSION
3.1 The terminology used in the above condition had effectively transferred to the ‘Contractor’ the ‘Right of Acceptance’ of the ‘Award’. Thus the ‘Client’ could not take any legal action against the ‘Contractor’.
3.2. In the above referred example the revised ‘LOA’ again contained the ‘Condition’ that was similar to the condition stated on the original ‘LOA’ dated 23 October 2002 whereby the ‘Contractor’ had the opportunity to reject the ‘LOA’ without any penalty and be bound to his contractual obligations.
3.3 This ‘terminology’ had been in common use in the past in most of the ‘LOAs’ that had been issued by the ‘Client’. It is interesting that most of the Suppliers/Contractors with similar conditions had subsequently revised the stipulated conditions and increased their rates. It was suspected that the Contracts Department was in collusion with the Suppliers/Contractors but this could not be conclusively proved.
3.4 The case was discovered by the Internal Auditor who was appointed by the ‘Client’ with specific responsibility to audit the various aspects of the mega construction contracts that the ‘Client’ had received and several sections that were being sub-contracted. The Internal Auditor had the relevant knowledge and experience pertaining to construction matters or procurement of building materials.
3.5 It was discovered that the above referred wrong terminology practice had been ongoing for some time but its dangers were not detected by the Finance Department of the ‘Client’ even when it noticed the increase in rates. The response was that the Finance Department was not conversant with the contractual matters and that the ‘Client’ had qualified and experienced technical/legal professionals who were responsible for the contractual matters and had recommended the ‘LOAs’ for the approval of the Board of Directors.
4.0 RECOMMENDATION
4.1 The Client normally determines the Terms and Conditions of the Contract, the Rates and the Duration Period of Acceptance/Rejection and the contractor/supplier agrees to comply and keep his prices firm during this period that is generally referred to as the ‘TENDER VALIDITY PERIOD’.
4.2 This case illustrates the importance of terminology of construction contracts/agreements that are incorporated in the formal contract documentation and their financial and legal implications. Thus it is important that management of contract department obtain relevant legal expertise before finalization of contract documentation. It is equally important that the involved professionals familiarize themselves of these aspects to enable them to implement and manage the contracts efficiently and effectively.
4.3 It is further noted that blind trust in technical professionals can be detrimental to the financial health of the ‘Client’. Also the financial professionals should show interest in the many aspects that have financial/legal implications of the projects. Blind trust provides opportunities for fraudulent practices to those in trust who are not monitored.
4.3 In the above case, the building industry was in a ‘boom’ period and the ‘Supply of Ballast’ could be referred to be a ‘Sellers’ Market whereby the seller can take the opportunity to revise the contractual conditions and rates if they have not been legally bound to it. It is strongly recommended and important that the Right of Acceptance or Rejection should be retained and exercised by the ‘Client’ especially in a ‘Seller’s Market’ situation. Further, it is not only in the best interest of the ‘Client’ but it is the normal practice in all Contracts/Agreements that the FIRST PARTY [CLIENT] SHOULD RESERVE THE RIGHT TO ACCEPT OR REJECT ANY TENDER/OFFER THAT IS SUBMITTED BY ANY SECOND PARTY [CONTRACTOR/SUPPLIER]. The Client would also be able to make revisions to Terms and Conditions and revise the Rates in a ‘Buyer’s Market’ when there is glut in the market of the required items for which an LOA has yet to be issued]
4.4 It is also important that the Internal Auditor obtains and equips himself with legal knowledge in respect of terminology used in clauses, terms and conditions that are incorporated in Construction Contractual Documentation. In this particular case the Internal Auditor was assigned the additional responsibility to provide on regular basis training and briefings to the finance and other staff of the company on various aspects of contract management and monitoring. The added knowledge and provision of training responsibility will add value to the Internal Auditor and to any Audit of Construction Contracts.
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GSK/June 06
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