Case Study: $30,000 Frigidaire
Neither the contractor nor the owner had any idea that such a small issue could snowball into an incident of such proportions. At first, it did not look as though such a small issue could grow into a situation of uncontrolled words and behaviors, and almost bring the whole project to a halt.
And, such a small issue was called in the contract specification, “special cooling device.” Its cost of $30,000 in a half-a-billion-dollar international project was almost nothing, but as the experienced know, the poison comes in small bottles. According to the contract procedure, every piece of the hard-special cooling device ware that the contractor delivered for a project had to be physically accepted and taken in the property by the owner’s committee of experts. This process is called physical inspection and acceptance.
This is a critical incident designed with the specific purposes of introducing a type of contract and the contract situation that seems to have both sides to react in a way as their contractual rights are breached. More specifically, the contract type is the turn-key contract that is not much used in the United States but is appropriate for U.S. companies transferring technology to less developed countries.
The Turn-Key Contract: The contractor is a $1 billion, a European company that makes a living building industrial plants, like the one in this critical incident, mostly using turn-key contacts. The owner is a state-owned manufacturer from the Middle East.
To oblige with the contract, the contractor’s engineers submitted what they called a “special cooling device.” When the owner’s engineers saw it, it is fair to say that they looked astonished. Also, there was rather unusual behavior. It more resembled some secret ritual than the work of an engineering committee. This was what the owner’s engineers did: They spent about 10 minutes going around it, looking at it from different angles with intense curiosity, opening the door of it, putting their heads inside, making different facial grimaces, whispering to each other, all the time not asking any questions.
Finally, they said they would be back in 20 minutes, without mentioning what the problem was, for it was obvious that the whole situation smelled of a problem. After the 20 minutes they came back with a verdict in writing—the owner’s committee was presented with an offer of an ordinary Frigidaire, asserting that it was a special cooling device, and the contract sum was to be reduced by $29,600, or to be determined on the level of the price of an average Frigidaire.
The heated debate began. Everyone on both sides formed an opinion and shared it publicly and unselfishly. It appeared as though no one had control of the situation; at least neither management side did. In uncontrolled discourse, words like “the contractor is dishonest,” and “the contractor is ripping us off” on the owner’s side and “the owner does not understand the contract” on the contractor’s side began to circulate. The conflict bubble was close to bursting.
This was a “turnkey” contract that was never really understood by anyone on the site. Basically, the essence of the contract is “function of the entirety.” That means that the contractor guarantees that the plant which is the subject of the contract shall function. It also means if the contractor “forgot” to include in the contract specification an item which is necessary for the plant’s function of the entirety, the contractor shall deliver the missing item free of charge. Moreover, the contractor is to “use and choose” subcontractors in a coordinated way in order to realize the function. For both of the essentials – the entirety of function and coordination of subs—the contractor is entitled to a fee between 20 and 30 percent of the contract sum.
Regarding the dispute about the special cooling device, the owner’s engineers thought that the contractor’s delivery of a Frigidaire for $30,000 was a huge rip-off, and so reducing the contract specification item to the Frigidaire price would be the only fair outcome. They did not recognize that the contract was the turn-key. The contactor’s opinion, of course, is based on their understanding of the meaning of the contract type. They based it on a recent example of delivering, free of charge, an overhead crane, which was not part of the contract specification. Namely, the contractor established the need for the crane in the process and delivered it to secure the function of the entirety. The contractor presumed that the item figure of $30,000 for the special cooling device was proper. The device was not a typical Frigidaire one could buy anywhere; it was a special industrial Frigidaire bought in Germany from a manufacturer of specialty cooling equipment. For that reason, the contractor was against the reduction of the item contract price. As there was no change in the total contract sum when the contractor delivered any item free of charge to secure the entirety function, there should be no change of the total contract sum in the case of typos or similar instances.
As the contractor held his ground, the owner contacted his headquarters, specifically, the corporate contract department, with the question of how to proceed in this case. To the owner’s surprise, he was told to leave the issue to the contract department, which is responsible for cases like this.
1. What are the major traits of turn-key type contracts?
2. What are the major traits of unit type contracts?
3. Contrast the attributes of turn-key type contracts with those of unit type contracts.
4. Is the owner right in demanding the price reduction of the $30,000 Frigidaire?
5. Is the contractor right in refusing the price reduction of the $30,000 Frigidaire?