The Account After Termination: A Worked Example of Cost to Complete

What the financial account looks like after a construction contract is terminated for default, worked through in illustrative riyals from the last valuation to the final position.

After termination the parties have to settle an account, and the usual basis is a comparison between what the works ultimately cost and what they would have cost had the original contract run to completion. The arithmetic is straightforward; the difficulty is evidencing each line. This example follows one account from the last valuation through to the balance, using illustrative figures.

The situation

A building contract with a sum of 22,000,000 riyals is terminated for contractor default in month fourteen of a twenty month programme. Certified work to date is 13,400,000 riyals gross. The owner appoints a completion contractor on a remeasured basis. The question is what the final account between the owner and the original contractor looks like, and who ends up owing whom. Every figure below is an illustrative assumption used to show the method.

Assumptions (illustrative)

• Original contract sum: 22,000,000 riyals.
• Gross value certified to the original contractor at termination: 13,400,000 riyals, with retention of 670,000 riyals held at 5 per cent.
• Amounts paid to the original contractor: 12,500,000 riyals, leaving 230,000 riyals certified and unpaid.
• Completion contractor appointment, including a condition survey and remedial work to defective items: 10,600,000 riyals.
• Owner additional costs: supervision extension 420,000 riyals, legal and expert fees 380,000 riyals, security and site care during the gap 95,000 riyals.
• Delay: completion six months later than the original date, with delay damages stated at 55,000 riyals a week and an overall cap of 8 per cent of the contract sum.

Step 1: Establish what the works would have cost under the original contract

The original contract sum of 22,000,000 riyals is the starting point. Adjust it for variations instructed before termination, assumed here at a net addition of 300,000 riyals, giving an adjusted contract sum of 22,300,000 riyals.

This is the benchmark against which the actual cost is measured. Getting it right matters, because the whole account is a comparison with this figure and every variation adjustment moves it.

Step 2: Total what the works actually cost the owner

Gross value certified to the original contractor of 13,400,000 riyals, plus the completion contract of 10,600,000 riyals, gives 24,000,000 riyals of construction cost.

The construction cost alone exceeds the adjusted contract sum by 1,700,000 riyals. That excess is the core of the owner claim, and it is the figure the original contractor will scrutinise line by line.

Step 3: Add the other costs caused by the termination

Supervision extension of 420,000 riyals, legal and expert fees of 380,000 riyals and site care of 95,000 riyals total 895,000 riyals. Adding these to the excess gives 2,595,000 riyals before any delay damages.

Whether each of these heads is recoverable depends on the contract wording. Professional and legal costs in particular are frequently contested, so each line needs a clause behind it as well as an invoice.

Step 4: Calculate the delay damages position

Six months of delay is about 26 weeks at 55,000 riyals, giving 1,430,000 riyals. The cap is 8 per cent of the contract sum, which on 22,000,000 riyals is 1,760,000 riyals, so the damages fall within the cap.

The delay figure has to be assessed net of any extension of time the original contractor would have been entitled to, and the contractor will argue that part of the six months arose from the owner own procurement of the completion contractor. That argument is usually the largest single issue in the account.

Step 5: Bring in the amounts held and owed

The owner holds retention of 670,000 riyals and owes 230,000 riyals of certified unpaid value, a net 440,000 riyals in the owner hands. Deducting that from the claimed total of 2,595,000 riyals plus damages of 1,430,000 riyals, which is 4,025,000 riyals, leaves a net claim of 3,585,000 riyals.

Retention and unpaid certified value are the only amounts the owner controls without pursuing anybody. Everything above them has to be recovered from the contractor, from a security or not at all.

Step 6: Test the claim against the recoverable security

If the performance security is 10 per cent of the contract sum, it stands at 2,200,000 riyals. Against a net claim of 3,585,000 riyals the security covers about 61 per cent, leaving 1,385,000 riyals to be recovered from the contractor itself, which on a default termination is frequently the least collectable part.

This is the practical lesson of the whole example. A security sized by convention rather than by an estimate of the cost of completion leaves a material shortfall exactly when it is needed, and that is the calculation to do at tender rather than after termination.

What changes the answer

• Extension of time entitlement: if the original contractor establishes an entitlement to eight weeks, the damages fall by about 440,000 riyals and the net claim moves with it.
• Completion contract basis: a remeasured appointment produces a defensible cost record, whereas a negotiated lump sum invites the argument that the owner failed to mitigate.
• Condition survey quality: without a survey at the transfer date, the owner cannot separate original defects from completion contractor work, and a large part of the remedial cost becomes unprovable.
• Recoverability of professional and legal costs: whether these heads are allowed depends on the contract wording, and excluding them changes the claim by nearly 800,000 riyals in this example.
• Security sizing: a security set at 10 per cent against a shortfall of this size shows why the sizing exercise belongs in the tender stage, when the cost of completion can still be estimated calmly.

What the numbers tell you

• The account is a comparison between what the works actually cost and what they would have cost under the original contract, so the adjusted contract sum has to be established first.
• Each head of additional cost needs a clause behind it, not just an invoice, and professional and legal costs are the most frequently contested.
• Delay damages must be assessed net of the extension of time the original contractor would have been entitled to, including any delay caused by the owner own procurement.
• A condition survey at the transfer date is what makes remedial cost provable, and it cannot be created later.
• Performance security sized by convention rather than by the estimated cost of completion leaves a shortfall precisely when it matters.

Limits of this example

Every figure above is an illustrative assumption used to show the method, not a quote, valuation or market rate. Costs, rates, fees and regulations change and must be confirmed with the relevant authority, lender or supplier before you commit.

Domira builds and supervises projects across Saudi Arabia, and the commercial discipline above is how its projects stay inside their budget and their programme. Send the drawings, the contract or the site and Domira will tell you where the risk actually sits.