EAST AND WEST COMPARED: A CRITICAL REVIEW OF TWO ALTERNATIVE INTERIM PAYMENT SYSTEMS AS USED IN HONG KONG AND THE U.K. ON MAJOR CONSTRUCTION WORKS

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1 EAST AND WEST COMPARED: A CRITICAL REVIEW OF TWO ALTERNATIVE INTERIM PAYMENT SYSTEMS AS USED IN HONG KONG AND THE U.K. ON MAJOR CONSTRUCTION WORKS Keith Potts, School of Construction, Engineering & Technology, University of Wolverhampton Dennis Toomey, Hong Kong Mass Transit Railway Corporation KEY WORDS Interim payments, pre-determined stage payments, milestones, "S" curve Summary The normal practice in the construction industry is for the contractor to be paid monthly advances during the execution of the works. The value of these payments being determined by agreement, often based on measurement, between the employer and contractor. However the Latham Report, published in the UK in July 1994, recommended that clients implement a new regime with payment against the achievement of milestones, activity schedules or payment schedules. Two different alternative payment systems have been developed and used - one in Hong Kong the other in the United Kingdom. Both of these systems utilise the concept of monthly payments based on pre-determined stage payments linked to the achievement of satisfactory progress monitored against milestones or the construction programme. Payment under the Hong Kong model, which was developed by the Hong Kong Mass Transit Railway Corporation and subsequently adopted for Airport related projects, is based on a cash flow pre-determined by the contractor and included in his bid. In contrast payment under the UK model [GC/Works/l(Edition 3)], which was devised by the Property Services Agency representing the UK Government, is based on a standard "S" curve established by the client and included in the contract. This paper critically examines and compares the effectiveness of these two systems. Introduction The Latham Report (1994) is a most ambitious attempt to reduce conflict and increase productivity in the UK construction industry. The Interim Latham Report, published in December 1993, identified that some clients were concerned that the traditional method of calculating monthly interim certificates based on measurements was not necessarily the best way to ensure satisfactory progress of construction contracts. The Interim Report further identified that there was an increased interest in negotiating agreed stages of work before the start of the contract, and payment being made when those stages are met. The aim of this paper is to briefly describe two different alternative payment systems - one used in Hong Kong the other in the UK - which have both been designed to link interim payments to satisfactory progress. The paper will firther examine the effectiveness of these payment systems based on the responses to a questionnaire sent to the main parties who have used them.

2 =Hone KO~Q Model General comments In 1978 the Mass Transit Railway Corporation (MTRC) introduced the concept of a monthly payment system based on the application of pre-determined percentages (Interim Payment Schedule percentages) to the total value of specified major elements of the works - linked to the achievement of "milestones". The system had been devised by the MTRC and Freeman Fox (now Acer Consultants). Milestones "One very important aspect of the MTRC approach was the identification of key dates for the required progress of each contract within the overall time frame of the project and their inclusion in the contract documents" (Sharpe, (1987)). "Critical dates" were generally applicable to a stage of completion and contract interface and were subject to liquidated damages whilst "milestone dates" were designated for the start or completion of activities. In general terms milestones were identified at about 3 month intervals during the period of completion for the works for each cost centre. However cost centre "A" contained only one milestone "submission of programme" Typically on a major civils project there would be 10 critical dates and over 60 milestones. Interim Payment Schedule (IPS) The bills of quantities were divided into "Cost Centres" reflecting major elements of work e.g. a station or tunnels between stations. There were between 4-8 cost centres per contract with cost centre "A" containing the general items, or preliminaries applicable to the whole contract. A separate Interim Payment Schedule (IPS) was provided for each cost centre. At tender stage each contractor was required to insert their required percentages for monthly payments against each cost centre. The IPS system thus enabled contractors to recover their initial mobilisation costs which on an international project of this magnitude were likely to be considerable. Provided that progress was satisfactory and the key dates met then payment would be made based on the full percentage value as bid. If one of the original milestone dates, or any subsequently revised date due to an extension of time award, was not met payment against the relevant cost centre was suspended. The IPS was then amended by a graphical method taking into account the date by which the non- achieved milestone would be achieved and the intervening percentages were re-evaluated accordingly; reference (Potts, (1988)) describes the procedure in detail. The system required that prior to payment to the contractor certain adjustments, i.e. additions and omissions were made to the value of each cost centre including: provisional sums, P.C. sums for nominated subcontractors, variation orders and the value of measured work. Benefits to the client By using this system the MTRC gained several benefits including: the ability to compare the true amount of tenders by using the discounted cash flow method by evaluating all tenders on a Net Present Value basis - in effect penalising contractors who have front-end load their tender, identification of the project cash-flow liability, senior management able to monitor progress simply by monitoring the cash flow, obtaining contracts which positively motivated contractors to meet key milestone dates and complete the works on time; thus providing a link between performance and payment and rewarding the efficient contractor., reduction in measurement staff needed to prepare monthly interim valuations.

3 greater likelihood of obtaining completion within time and cost, thus obtaining best value for money. David Sharpe, the former Chief Civil Engineer of the MTRC considered that "This payment system and its link with the Milestone Dates provided everyone (and particularly the construction management) with a clear and unequivocal measure for progress, and assisted management efforts towara3 the aim of completion on time." (Sharpe, (1 987)) New developments The IPS system was subsequently adopted and used by the Highways Department and one of Hong Kong's largest developers - the Hong Kong Jockey Club. The system is now used on the Airport Core Programme (ACP) and by the Provisional Airport Authority (PAA) as well as by MTRC on the Airport Railway. Generally there has been a certain amount of fme tuning on the payment system on MTRC, PAA and ACP contracts - mostly geared to ensuring a closer link between the IPS and the milestone schedule including: restraint on the total percentage amount to be included in Cost Centre A (preliminaries) restricted to 20-25%, 0% sometimes included by the Engineer in the IPS as part of the tender documentation to prevent excessive fiont loading, many more milestones in respect of Cost Centre A, payment restraints of minimum 2.5% between milestones and maximum 97.5% prior to completion of last milestone, greater power for Engineer to change the IPS and milestone schedule e.g. in the event of extensions of time or significant change to the cost centre value. The UK model General comments The Lump Sum with Quantities version of GC/Works/l (Edition 3) or to give it its full title "The General Conditions of Contract for Building and Civil Engineering" was first published in December 1989 and republished, after drafting changes, in GC/Works/l(Edition 3), which is intended for use on Government building or civil engineering works over 150,000, was developed by the Property Services Agency (PSA) of the Department of Environment. Stage Payment Chart Clause 48 "Advances on Account" introduces an entirely new concept providing for the payment of monthly interim payments based on a pre-determined "S" curve which was calculated by the PSA following analysis of over 500 projects. A "Stage Payment Chart" model form for projects above 5,500,000 is included in the back of the Conditions. The Stage Payment Chart (SPC), which is included in the tender documents links the monthly payment to satisfactory progress on a standard percentage basis. Retention is not considered on the charts and separate charts are available for nominated subcontractors. Contractors should therefore include in their tenders for any divergence between the likely payments and the anticipated resource cost. Provided that relevant instructions have been complied with and the work is to the satisfaction of the client's project manager then the contractor is paid monthly advances based on 95% of the proportion of the sum specified in the Stage Payment Chart for that month. Payments for variations and for prolongation and disruption are treated separately.

4 The client's project manager is firher given the power to amend the stage payment chart to reflect actual progress and any changes resulting from cost saving proposals under clause 52. The chart should be adjusted following the statement recorded by the project manager in the monthly progress meetings that the works are in delay or ahead of the programme. Programme Monitoring of the programme, which is normally submitted by the contractor within 2 1 days of contract award, should be in accordance with the guidelines laid down in "Planned Progress Monitoring" (DOE, (1986)). The guidelines recommend that the network is re-drawn into a bar chart form, preferably as a linked bar-chart, in such a way as to continue to show the inter- relationship and timing of the activities and the critical path. The linked bar chart should, after each monthly progress meeting, be monitored using the activity time unit method [counting the squares (CTS)]. This system greatly simplifies the monitoring process, however in practice some "weighting" of the activities may be desirable. The achieved percentage completion can be plotted onto the "S" curve derived from the "Stage Payment Chart" and the percentage proportion of the contract sum payable established. The interim payment thus reflects satisfactorily completed works on a progress basis and is not based on the rates included in the bill of quantities. Research methodolo~e A questionnaire was prepared with the objective of obtaining information on the effectiveness of the two alternative payment systems. A total of 80 questionnaires were sent in Hong Kong and 60 in the UK - to both contractor and client representatives. The questionnaire comprised 20 questions (see below) reflecting those issues identified in the Latham Report (1). The questionnaire required the respondents to consider each of the twenty statements and using the scale provided to circle the number that indicated the extent to which they agreed or disagreed with the statement. By using this numerical approach a direct comparison could then be made between the contractors' and clients' views of the two systems. Additional comments were sought from all respondents in order that particular items of concern could be identified. Analysis A total of 57 questionnaires (41%) were returned analysed as follows: Hong Kong: contractors - 8, client representatives - 2 1, United Kingdom: contractors - 24, client representatives - 4. The quality of feedback was excellent as the questionnaires were generally completed in detail by commercial directors, construction managers, senior partners and senior engineers. The following scale was used in the questionnaire: Strongly disagree Neutral Strongly agree All numbers in the chart that follows reflect the mean of the returned questionnaires in the respective categories - generally the higher the score the more favourable the response.

5 HK (IPS) Contr. Client Contr. Client 1. Promotes satisfactory progress 2. Allows for negotiation of agreed stage payments before start of contract 3. Enables contractors to specify magnitude and timing of mobilisation payments 4. Enables prompt recovery of cash flow reflecting value of work executed 5. Enables bidders to specify their preferred duration 6. Monitoring of progress is fairly assessed 7. Penalises contractors who are ahead of programme 8. Prompt changes easily made to payment schedule to accommodate extra works 9. Prompt changes easily made to payment schedule to accommodate extensions of time 10. Allows for payments of formal incentives and bonus 1 1. Allows for sharing of savings identified by contractor 12. Rules of interpretation are applied consistently 13. Operates better with fewer cost centres (4-8) 14. Operates better with frequent milestones per cost centre (every 3 months) 15. System suitable for any building1 civils project 16. Enhances team-working 17. Encourages use of computerised project planning systems 18. Reduces conflict 19. Increases productivity 20. On balance, has worked well in practice Mean score of items reflecting sound project management (all less 7, 13-15)

6 Summary of other relevant comments: (I) HONG KONG - "Interim Payment System" (a) H.K. contractors' comments: "The achievement of milestones can be subject to differing opinions and interpretation." "Must involve a fairer interpretation of revision clauses than now where all discretion is with the client - however we have successfully re-negotiated IPS to reflect programme." One respondent suggested introducing an automatic review of IPS andor the descriptions andor dates of milestones every 6 months. On the same theme, another respondent considered there should be a clear mechanism whereby the client is obliged to change the IPS in accordance with the approved programme - limited to 6 occasions, say three upon the client's initiative and three upon the contractor's request. "Items 2,3 and 4 depend upon whether the tender documents impose unrealistic limits on the monthly % per cost centre. Contractors must be allowed to structure their IPS to suit their true costs. A tender assessment making use of Net Present Value would control abuse". "Ultimately it depends on the logic applied in application, PQSIclient can use the milestone description and the IPS revision clauses as a big stick. However I think it is a good system when properly applied - if not fairly administered by the client the system is no improvement on other payment procedures". "Many professionals (engineers, contractors, civil servants and lawyers) believe that ACP contracts are in breach due to the non issuance of e o t's for V.O.'s and delays by the engineerlclient. They have not correctly modified milestones etc promptly and thus affected the contractors income by delays to payment from the IPS. A much more flexible administration is required". (b) H.K. client representatives' comments: " A prerequisite for the success, or otherwise, of a milestone type IPS arrangement is that the client should have a reasonably settled design and a thorough understanding of the construction programme necessary to complete the works within the time scale identified." "Has worked well on MTRC projects. Is not a sophisticated system and requires a fair and reasonable interpretation of the "intent" of the milestones. It is essential that the milestones are selected on the "critical path" and the Engineer's programme is robust." "Considerable care must be taken when determining milestone descriptions and dates to ensure that they provide adequate control for the ClientEngineer without applying too much pressure on the contractor or restricting the contractor's cash flow too much.'' "However its one inherent problem is that unless variations are agreed and valued on a regular basis and the IPS adjusted accordingly then either an underpayment, or more likely an overpayment, will occur." "The IPS approach has been readily accepted. The client can control cash flow by limiting the percentage payment up to a certain month in any cost centre. More cost centres and fewer milestones per cost centre can overcome the effects of changes to programme logic. "The contract needs to establish the contractors anticipated cash flow with his tender programme. It allows a fmancial comparison to be made between tenders. More importantly it provides a basis for revised IPS values for a change in programme logic". "The milestone payment system is equally applicable to (indeed is probably the best system for design and construct projects (including B.O.T.) where a major problem exists over the ascertainment of interim payments

7 and progress without a conventional detailed B of Q at bid stage. The system is fairly simple in base concept but requires a holistic approach to its incorporation into a contract. It is not just a set of changes to Conditions of Contract, so its incorporation into Standard Conditions of Contract will also require a number of guidance notes on alterations to associated documents". "Adoption of the IPS system should ideally be limited to linear (horizontavvertical operations." However one respondent commented that the system would not be appropriate on a road contract with say 20 access points where sections may be completed out of sequence. Three other client representatives identified the difficulties of using the system on complex building projects with many trades - indeed one observed that "its disadvantages may outweigh its benefits in contracts for more complicated works", another considered the system "naive and dangerous" (2) UNITED KINGDOM - "Stage Payment Chart" (a) UK Contractors' comments " In principle the idea and general arrangement of stage payment charts is essential to improve productivity etc. but the chart needs to be agreed between the client/contractor and should reflect the actual circumstances directly. Standard "PSA" type payment charts are not the answer." " User friendly, very flexible, can be modified to make allowances for e.g. e.o.t., V.O.'s, progress etc. Enables managers to retain a good feel financially without having to resort to too much detail." Areas of concern related to: stage payments to subcontractors, method for calculating progress achieved, incorporation of variations, real possibility that contractor may have to part-finance some projects, internal financial reconciliations, no provision regarding payment for off-site materials, implementation by individuals administering contracts prevents system working effectively - "red tape within the Ministry of Defence" (b) UK client's comment: "The system is based on the accuracy of the appointee's assessment of programme progress, however this should be agreed with the main contractor." Conclusions the HK IPS system generally contributed more to effective project management than did the UK SPC system. UK client representative (a small sample) considered the UK SPC a far better system than did UK contractors. the HK IPS system achieved a higher score from the contractors than did the UK SPC system from UK contractors on all issues except: - item 5 (enables bidders to specify their preferred duration - this was a marginal difference), - item 7 (penalises contractors who are ahead of programme), - item 18 (reduces conflict - this was surprising; however, the Hong Kong client representatives took a more positive view of the Hong Kong IPS system), the Hong Kong IPS system works better on 'linear' projects and has limitations on complex building work, the success, or otherwise, of alternative payment systems can be directly attributable to the "reasonableness" and "promptness" of the client and the client's contract administrator in operating the scheme, the New Engineering Contract, recommended by the Latharn Report as the preferred contract, should be amended to incorporate an option of payment using the Hong Kong IPS system.

8 References Latham, Sir M., Constructing the Team: Final report of the Government/Industry review of procurement and contractual arrangements in the UK Construction industry, HMSO, Sharpe, D.J., Urban Railways and the Civil Engineer, Conf: London , ICE, Session 3 - Construction, Paper 10, Completing on time- construction management, pp Potts, K.F., An aiternative payment system for major "fast track" construction projects, Construction management and Economics, 1988, 6, Department of Environment, (DOE), PSA, Professional Practice and Management Group, Directorate of Quantity Surveying Services, Planned Progress Monitoring, 1986.

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