Skip to content

Project Finance & Financial Modelling · Capital structure, risk allocation and bankability · lesson 6 of 20 · 13 min

Contracts and procurement basics

Why contract form matters to finance

The contract model determines who carries cost and schedule risk, how prices change and how disputes are handled. For financiers and cost managers, the contract is where budget certainty is either secured or lost.

Main contract pricing models

| Model | How payment works | Cost risk mainly with | Best when | |---|---|---|---| | Lump sum / fixed price | Fixed price for defined scope | Contractor | Scope well defined; lenders want certainty | | EPC turnkey | Fixed price, date, single-point responsibility for engineering, procurement, construction | Contractor | Project finance of power, water, industrial plants | | Remeasurement / unit rates | Rates × measured quantities | Owner (quantity) / Contractor (rate) | Quantities uncertain (e.g., earthworks) | | Cost-plus / cost-reimbursable | Actual cost + fee | Owner | Scope unclear, speed critical; needs strong controls | | Target cost with pain/gain share | Target price; overruns/savings shared | Shared | Collaborative delivery; complex projects | | Design and build | Contractor designs and builds to owner requirements | Contractor (design + build) | Owner wants single responsibility |

Standard forms

Many projects use standard contract suites rather than bespoke contracts. Widely used examples include FIDIC (common internationally, including in the Gulf and Pakistan), NEC (widely used in the UK and increasingly elsewhere) and, in the US, forms such as AIA and ConsensusDocs. Standard forms bring predictability, but lenders will scrutinise amendments, especially those that shift risk back to the owner.

Key commercial clauses to understand

  • Scope and specification: what is included; ambiguity here is the root of most variations.
  • Price and payment: milestones or monthly valuations, advance payments, retention, payment periods.
  • Variations: how changes are instructed and valued.
  • Time: completion dates, extensions of time, delay damages.
  • Performance: tests, guarantees, performance damages.
  • Security: performance bonds, advance payment guarantees, parent company guarantees.
  • Liability caps and exclusions: limits on what the contractor can owe.
  • Price adjustment: indexation or fluctuation clauses for inflation or commodity prices.
  • Termination and dispute resolution: adjudication, arbitration, governing law.

The procurement process step by step

  1. Define requirements and strategy: packaging (one EPC vs multiple contracts), contract model, evaluation criteria.
  2. Market engagement: gauge interest and capacity; public bodies must follow applicable procurement rules.
  3. Prequalification: assess financial strength, experience, safety record, capacity.
  4. Tender (RFP/ITT): issue clear documents with a pricing schedule that enables like-for-like comparison.
  5. Evaluation: technical and commercial scoring; normalise bids for exclusions and qualifications.
  6. Negotiation and award: clarify, finalise contract terms, obtain approvals.
  7. Contract management: administer payments, changes, claims, performance.

Bid evaluation template

Criterion (weight)           Bidder A   Bidder B   Bidder C
Price (40%) – normalised      36         40         31
Technical solution (25%)      21         17         22
Schedule (15%)                12         13         14
Experience & capacity (10%)    9          7          8
Commercial terms/risk (10%)    6          8          7
TOTAL                         84         85         82
Key exclusions priced in:     +$1.2M     +$3.5M     +$0.4M

Always normalise bids: a low price with large exclusions or qualifications can become the most expensive once gaps are priced. In the example, re-scoring after pricing exclusions could change the ranking.

Worked example

Illustrative. A fictional Saudi logistics operator tendered a warehouse under a lump-sum design-and-build contract. The lowest bid was 9% below the next, but excluded ground improvement and fire-protection approvals. After pricing the exclusions, it was 3% above the second bidder. The operator awarded to the second bidder and avoided a likely early dispute.

Public procurement and integrity

Public projects must comply with procurement laws and anti-corruption rules (for example, the UK Bribery Act and US Foreign Corrupt Practices Act apply extraterritorially in many cases). Keep evaluation records, manage conflicts of interest and ensure transparency.

Common mistakes

  • Choosing contract models that do not match scope definition.
  • Evaluating on headline price without normalisation.
  • Accepting liability caps that make risk transfer illusory.
  • Poor contract administration after award, leading to disputed claims.

Quick self-check

For your next procurement, write down before tenders arrive: the contract model and why it fits the level of scope definition, the evaluation weights, and how exclusions and qualifications will be priced. Deciding these in advance protects the process against bias towards a favoured bidder and gives you a documented, defensible basis for award, which is essential for public bodies and increasingly expected by lenders and auditors.

Hands-on: a normalised bid evaluation in Excel

Columns: A Bidder | B Bid price | C Priced exclusions (mid) | D Priced exclusions (high) | E Normalised =B2+C2
F Price score (40)     =MIN($E$2:$E$4)/E2*40
G Technical (25) | H Schedule (15) | I Experience (10) | J Terms/risk (10)   (panel scores with written reasons)
K Total                =SUM(F2,G2:J2)
L Rank                 =RANK.EQ(K2,$K$2:$K$4,0)
M Rank if exclusions high:
   N2 =B2+D2 ; O2 =MIN($N$2:$N$4)/N2*40+SUM(G2:J2) ; M2 =RANK.EQ(O2,$O$2:$O$4,0)
Flag                   =IF(L2<>M2,"Ranking sensitive to exclusions: clarify before award","")

Record the weights and normalisation method before tenders are opened; keep the file as part of the evaluation record.

Template: tender clarification log

| Ref | Bidder | Clause/section | Issue (exclusion, qualification, departure) | Question sent | Response | Priced impact | |---|---|---|---|---|---|---|

Second worked example: a remeasurement package

Illustrative. A UAE developer procures bulk earthworks on unit rates because rock levels are uncertain. Bidder X has a lower rate for soft material but a much higher rate for rock. Evaluating at the geotechnical report's expected quantities, X ranks first; evaluating at the report's upper-bound rock quantity, X ranks last. The team evaluates on the expected case but negotiates X's rock rate down before award, closing the exposure.

How to measure success

  • Weights and normalisation rules documented before bid opening.
  • Every exclusion and qualification priced or clarified.
  • Ranking robust to high-end exclusion pricing, or clarified before award.

Video lecture: Contracts and procurement basics

Lecture coming soon · 9 chapters · about 8 minutes. Read the full transcript below.

  1. The contract is where certainty is won or lost
  2. Why it matters
  3. The concept: pricing models
  4. Standard forms and key clauses
  5. Worked example one: normalising a bid
  6. Worked example two: a Saudi warehouse tender
  7. Watch me do it: a weighted evaluation with normalisation
  8. Procurement steps and integrity
  9. Recap and try this now

Lecture transcript

The contract is where certainty is won or lost

Here's a tender result I've seen play out more than once. The lowest bid is nine per cent cheaper than the next. The committee is delighted. Then someone reads the qualifications and finds the bid excludes ground improvement and fire approvals. Price those exclusions, and the 'cheapest' bid becomes the most expensive. In this lecture you'll learn the main contract pricing models and where each puts cost risk, the standard contract forms you'll meet, the commercial clauses every finance professional should understand, the procurement process step by step, and how to evaluate bids fairly by normalising them. By the end, you'll be able to read a tender evaluation and spot when the ranking is wrong.

Why it matters

Why does this matter to finance? Because the contract model determines who carries cost and schedule risk, how prices change and how disputes are handled. For financiers and cost managers, the contract is where budget certainty is either secured or lost. In project finance, lenders scrutinise contracts closely, especially any amendments to standard forms that shift risk back to the owner. And a poorly run procurement can award to a bidder whose price looks low only because of exclusions, which often leads to claims, disputes and delay. A few hours spent normalising bids can save months of argument.

The concept: pricing models

Here's the key idea: each pricing model places cost risk somewhere different. Think of it like ordering a meal. A fixed-price menu means the restaurant carries the risk that ingredients cost more. Paying per item ordered means you carry the quantity risk. Paying the chef's costs plus a fee means you carry it all. In contracts: lump sum, or fixed price, for a defined scope puts cost risk mainly on the contractor, and suits well-defined scope where lenders want certainty. EPC turnkey adds a fixed date and single-point responsibility for engineering, procurement and construction, the standard for project-financed plants. Remeasurement, or unit rates, puts quantity risk on the owner, useful when quantities are uncertain, like earthworks. Cost-plus puts cost risk on the owner and needs strong controls. And target cost with pain and gain share splits overruns and savings, supporting collaborative delivery.

Standard forms and key clauses

Many projects use standard contract suites rather than bespoke contracts. Widely used examples include FIDIC, common internationally including in the Gulf and Pakistan, NEC, widely used in the UK, and in the US forms such as AIA and ConsensusDocs. Standard forms bring predictability, but watch the amendments. Now the clauses every finance person should read. Scope and specification, because ambiguity here is the root of most variations. Price and payment: milestones or valuations, advances, retention and payment periods. Variations: how changes are instructed and valued. Time: completion dates, extensions and delay damages. Performance tests and damages. Security: performance bonds, advance payment guarantees and parent company guarantees. Liability caps and exclusions. Price adjustment clauses for inflation or commodities. And termination and dispute resolution: adjudication, arbitration and governing law.

Worked example one: normalising a bid

Let's normalise two bids with simple, illustrative numbers. Bidder A prices twenty million, with exclusions you estimate at one point two million. Bidder B prices nineteen million, with exclusions estimated at three point five million. On headline price, B wins by a million. Normalised, A is twenty-one point two million and B is twenty-two point five. A is now cheaper by one point three million. Normalisation means pricing every exclusion, qualification and departure from the specification, so you compare like with like. Decide the method before tenders arrive, and apply it the same way to every bidder, so the process is fair and defensible.

Worked example two: a Saudi warehouse tender

Now the realistic example from the lesson. A fictional Saudi logistics operator tendered a warehouse under a lump-sum design and build contract. The lowest bid was nine per cent below the next. But it excluded ground improvement and fire-protection approvals, both of which the site clearly needed. After pricing those exclusions, the lowest bid was three per cent above the second bidder. The operator awarded to the second bidder, and avoided what would almost certainly have been an early dispute over who pays for ground works. Notice what made this possible: a pricing schedule that allowed like-for-like comparison, and an evaluation team that read the qualifications as carefully as the prices.

Watch me do it: a weighted evaluation with normalisation

Let me show you the evaluation sheet. First, weights, agreed and recorded before any tender is opened: price forty per cent, technical solution twenty-five, schedule fifteen, experience and capacity ten, commercial terms and risk ten. For price, I don't score the headline. I add a column for priced exclusions and calculate a normalised price. The price score is the lowest normalised price divided by each bidder's normalised price, times forty. So the cheapest normalised bid gets the full forty. Technical and other scores come from the evaluation panel, each with written reasons. A SUM gives the total, and a RANK formula orders the bidders. Then I run one test: does the ranking change if exclusions are priced at the high end of my estimate? If it does, that's worth a clarification round before award.

Procurement steps and integrity

The procurement process, step by step. Define requirements and strategy, including packaging and contract model. Engage the market to gauge interest and capacity, following applicable rules for public bodies. Prequalify on financial strength, experience, safety record and capacity. Issue the tender with a pricing schedule that allows like-for-like comparison. Evaluate technically and commercially, normalising for exclusions. Negotiate, finalise terms and award. And then manage the contract: payments, changes, claims and performance, which is where much value is won or lost. Public projects must also comply with procurement law and anti-corruption rules; for example, the UK Bribery Act and the US Foreign Corrupt Practices Act can apply extraterritorially. Keep evaluation records, manage conflicts of interest and be transparent.

Recap and try this now

Let's recap. Choose a contract pricing model that matches how well the scope is defined, because each one places cost risk differently. Read the clauses that finance depends on: scope, payment, variations, time, security, caps and price adjustment. Run procurement in clear steps, with evaluation weights and normalisation rules fixed before tenders arrive, and always price exclusions before ranking bids. And manage the contract actively after award. The common mistakes are the opposite: contract models that don't match scope, headline-price evaluation, liability caps that make risk transfer illusory, and weak contract administration. Your try-this-now: review a contract you have access to, or a public summary of a standard form, and list the clauses covering payment, variations, delay damages and liability caps.

Key takeaways

  • Contract model determines who carries cost and time risk; EPC turnkey is common in project finance.
  • Understand key clauses: scope, payment, variations, time, performance, security, liability caps, indexation.
  • Run procurement in stages and normalise bids for exclusions before comparing.
  • Standard forms (e.g., FIDIC, NEC) add predictability; scrutinise amendments.

Try it

Review a contract you have access to (or a public standard-form summary) and list the clauses covering payment, variations, delay damages and liability caps.