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As we wrap up procurement month, I want to talk to you about performance-based contracts. These are very different from most other contracts. They can be complicated to write, but if awarded to a competent bidder, can bring guaranteed results.

In the length of a column, it is impossible to cover all the items necessary to include in a performance based contract. Even in a relatively small project, the development of the contract can take considerable time and the contract can run to hundreds of pages.

Why would one engage in a performance-based contract? There are several reasons. One may be a demand from one's board of directors or one's lenders; they want to make sure they are obtaining exactly what they want to procure. Another reason may be that one does not have the staff or expertise to execute the work to be done. Finally, the project may require bringing together several contractors of specialized expertise and coordinating them in a special way--this is something of a subset of the second reason given, but taken a step further.

So what's in such a contract? Time, money, space, specifications for materials of construction and performance parameters. There will also be a lot of language about following all applicable laws, obtaining all applicable permits and so forth and so on. Likely there will be language about providing operator training, guarantees on workmanship and durability. This is just the high level stuff.

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One can usually walk into a facility and quickly determine if it was built on a performance-based contract. If it was, and the contract writer was not diligent in details, the facility will appear quite Spartan, perhaps dated (after all, you did not specify that you wanted windows in the control room!).

A performance based contract, besides having a price, location of the work, and time to complete will necessarily have some bonus/penalty clauses. There will be a bonus/penalty on completion time. By the way, it does need to be a bonus/penalty--not just a penalty if not completed by a certain date. This is what lawyer's call balance--if it is completed ahead of time, there is a bonus, past the deadline there is a penalty. As for performance when complete, the provision for failure to build a facility that does not perform to specifications is called "liquidated damages." This is usually a formula spelled out in the contract stating that if the facility, for instance, meets 98% of production capacity, then the contractor owes the owner xx% cash in damages.

It takes a long time to write a good performance-based contract. Once the contract is written and awarded, however, the owner's responsibility is to provide clear and easy access to the location of the work and stay out of the way. Many a contractor has successfully avoided penalties and liquidated damages due to interference from the owner.

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I should hasten to say a performance based contract does not have to be all inclusive of everything involved in a project. It may be just for certain key pieces of machinery. It may be for the construction phase. It may be for any portion you wish to carve out of the project. Just remember, such a performance based contract covers only its scope of work and may not ensure a successful overall project.

Finally, a performance-based contract may or may not be a firm lump-sum contract. Example: you may decide you need 10,000 hours of labor from highly experienced electricians. You can find someone who will sell you this. All they have to be is "highly experienced" (whatever that means). It does not mean they have to do your project in a satisfactory way. Maybe you ran out of electrical tape (an item you are supposed to supply) and they did a lot of standing around. Not the contractor's fault; it is your fault and they are due their payments.

I give this last example to demonstrate how detailed one must be when preparing such contracts. You have to think of everything. Consider this, however--in any contractual situation, you will have to think of everything sooner or later. Doing so before the "heat of battle" commences may just be the best choice for you.

Any experiences with performance based contracts? Take our quiz this week and let us know.

Performance based contracts must have a provision binding the contractor to complying with all applicable safety rules, regulations and laws. Make sure these are covered--don't leave anything to chance.

Be safe and we will talk next week.

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