Need to Know—Using Owner-Supplied Materials

By Jim Lennington, PE 

There are times when it may make sense for a facility owner to pre-purchase materials for installation. In regional water system development one of the more common examples of this is the purchase of process equipment prior to final design and construction. The primary reasons for this are to allow the treatment process to be selected in advance based on pilot testing of available equipment and to allow the design of the facility to incorporate the dimensions, piping connections and other features of the process equipment that will be used verses developing a less refined design to allow the incorporation of multiple supplier options. Another reason for pre-purchasing equipment is the potential for saving cost by avoiding the contractor's markup, which in our experience is typically 10%-15% for materials purchased from a vendor.

There are however, some considerations which should be included in the decision making process before equipment is pre-purchased.

Contract Administration
The potential for saving money by avoiding the contractor's markup on equipment is partially offset by increased contract administration. Rather than having one contract with a contractor, the owner and engineer have another set of contract documents to develop and administer, including pay estimates, change orders, and other written communication instruments. The submittal process will still take place but may be streamlined due to the lack of general contractor as a middle man. The owner's legal counsel has two sets of documents to review and approve, and so on. Costs for these items may not be readily apparent, but if the equipment purchase is not substantial, i.e. less than $100,000, these administrative costs could easily exceed the cost savings.

Contract Documents
Contract documents form the basis of the legal arrangement between an owner, engineer, and a contractor and aid in assigning the risk on the project. In the procurement contract the arrangement is between buyer (owner), and seller, with many of the same provisions as in the standard construction contract. The engineer acts as the owner’s representative as in a construction contract. A key difference is that instead of “substantial completion,” the main milestone is the date of delivery, or acceptance date, for the equipment being purchased. The owner and engineer need to understand the equipment delivery dates will have an effect on the final construction schedule, and that proper coordination is required. The owner needs to consider and understand the risk that delayed equipment delivery will delay construction and potentially lead to contractor claims for damages. The opposite also needs to be considered: that the equipment is ready for delivery but can't be accepted because of a delay in progress of the construction contract. It is reasonable in such an event for the equipment supplier to claim additional costs due to delayed delivery. The Engineers Joint Contract Documents Committee (EJCDC) Standard General Conditions for Procurement Contracts expressly states (7.03.D) the seller is entitled to additional costs arising of out a delay attributable to the buyer. These costs could include financing charges, storage costs, increased shipping, delayed profits, or other such reasonable costs incurred by the equipment supplier.

Insurance and Liability during Construction
Typically, the procurement contract has provisions for how and when the equipment is to be delivered. The contract typically specifies at what point the owner takes possession of the equipment and that the owner is responsible for unloading, storage, and installation. The owner and engineer in turn need to incorporate the appropriate provisions in the contract for installation of the equipment in order to avoid a situation in which the owner is responsible for the equipment while it is being installed by the installation contractor. In most instances the installation contractor is made responsible for coordinating and taking delivery of the equipment, storing it according to the supplier's instructions, and its proper installation. It is a good idea to require that the contractor have prior experience with installation of equipment of a similar nature. Also, the provisions of the installation contract need to be clear on the insurance coverage required and who is responsible for the equipment at various phases so that any damage to the equipment is covered. The Builder's Risk policy for the installation contract should be in an amount that includes the owner-purchased equipment. Removal of the exclusion on the Contractor's General Liability policy for "property under the care, custody, and control" of the contractor can be difficult to get from the contractor's insurer.

Sales Taxes, Use Tax, and Contractor’s Excise Tax
Most states require payment of sales taxes for purchase of equipment, supplies, and services by utilities and governmental entities, or a use tax when the materials are provided by an entity which is not responsible for the payment or collection of sales tax. When a contractor purchases and installs equipment for regional or community water systems, the contractor is considered the final user or consumer of those materials. These sales are subject to sales taxes. When a contractor installs equipment purchased by someone else the contractor has to pay a use or sales tax on the equipment or certify that the taxes have already been paid by the owner. This requirement should not be forgotten and should be included in one or the other of the contracts. The final certification that the sales taxes have been paid can be included as required documentation of contract close-out.

Some states also have a contractor’s excise tax, or a tax on construction of facilities, that is paid by the contractor and incorporated into his price. That tax is on the total amount of construction and would include any materials supplied by the owner. As such, the contractor must be advised of the costs so that the appropriate tax can be incorporated into their bid.

Summary
Owner-supplied materials can have their advantages in the construction of projects, but those advantages also come with some items to be carefully considered prior to proceeding. Proper care in planning and coordination is required to minimize any unintended circumstances that could lead to claims or unforeseen costs due to improper assignment of responsibilities.