Insufficient oversight of a contractor and poor contract management may have resulted in the City of Palo Alto Utilities paying roughly $281,000 more than it should have, a new audit from the office of Acting City Auditor Houman Boussina has found.

The audit, which was released Wednesday afternoon, targets the city's contract with Casey Construction, a company that dug trenches and provided underground electric work to the city between 2009 and 2012. It highlights a number of flaws in the way the city awarded and administered the contract and criticized the Utilities and Administrative Services departments for their failure to maintain necessary documents and adequately monitor the work being done.

"Due to inadequate documentation and the nature of the work, we were unable to provide reasonable assurance that the city paid for work that had been appropriately planned and executed under the terms and scope of the contract," Boussina wrote. "A lack of adequate procedures and controls to manage the contract and monitor the performance of the contractor greatly increased the risk of fraud, waste and abuse."

Boussina made four critical findings about the Utilities Department's contract with Casey -- a contract that began with a flawed bid and that ultimately spanned three years and totaled about $1.9 million.

The audit found that the city did not "effectively address" the large gap between the city's estimate for the work and Casey's bid (which was 35 percent below the estimate); the city "did not appropriately re-evaluate or renew the City's contract"; the city did not enforce the billing terms on which the contract was based; and the city did not appropriately manage the contract.

When the city approved the contract in August 2009, it had intended to manage most of the trenching services under "lump sum" pricing, in which a fixed rate is set for a service. The fixed prices put the burden on the contractor to contain costs and are thus considered a low-risk strategy for the city, the audit notes. But in the end, only 19 percent of the $1.9 million that the city paid to Casey was based on fixed prices.

About $1.4 million, or 74 percent, was based on "optional bid line items," for which the contractor charges the city based on time and material expenses. As Boussina points out, such contracts provide "no positive incentive to the contractor for cost control or labor efficiency, requiring additional controls to ensure efficient methods and effective cost controls are being used."

Another $144,141 was spent on items "not identified by any line item in the contract." Tomm Marshall, assistant director of engineering in the Utilities Department, said this sum was spent on an excavator that was needed for a project.

Utilities and Administrative Services officials acknowledged on Wednesday that the city's contract-administration process needs improvement and outlined their strategy for addressing the auditor's recommendation. These include enhanced training procedures for contract management, staffing changes to ensure more contract oversight, better use of technology and more stringent record keeping. In the Utilities Department's engineering division, which was the target of the audit, one position has already been reclassified and charged with contract administration, Marshall said.

Utilities Director Valerie Fong said some of these initiatives had been launched even before the audit. She acknowledged that there had been "procedural lapses" in the department's contract administration, but stressed that these mistakes "did not in any way diminish the value of the services that we needed and paid for under the contract."

"We really do recognize that contract administration is extremely important and we are really committed to improving our processes, our procedures and our training to ensure contracts are properly executed and administered," Fong said.

Some of the reasons for the inadequate oversight had to do with inexperienced staff, she said. Over the past four years, the engineering and operations divisions have seen a 40 percent turnover. This was partly because of the council's decision in the economic downturn to reform the city's pension formula and require a greater contribution from employees. One of the unintended consequences was a spike in retirements and a resulting loss of workers with decades of experience.

"As a result, we had staff who were not necessarily fully trained in every aspect of contract management," Fong said.

At the same time, with construction projects ramping up again as the economy revived, the city saw more demand for underground utilities work, officials said. The higher-than-expected number of customers surpassed the staff's estimate and prompted a gradual switch from the safer "lump sum" methodology to the "time and materials" one that favored the contractor, Marshall said. The contract effectively became an "ad hoc" agreement based on customer requests, he said.

The city's agreement with Casey was made despite the contractor's admission that its bid, while low, was based on flawed assumptions. In particular, Casey didn't factor in a provision having to do with paving, said Lalo Perez, the city's chief finance officer. Nevertheless, after city officials spoke to Casey and explained this provision, Casey agreed to honor its contract and abide by its terms. The audit suggests that the city's decision to award the bid despite the early errors may have contributed to the complications that occurred down the road.

"Based on available evidence, including correspondence with Casey staff and actual Casey contract billings, we conclude that while the city awarded the contract to the lowest bidder, it did not award the contract to the lowest responsible and responsive bidder, which may have resulted in additional costs of approximately $281,000," the audit states.

The figure assumes that the city would have awarded the contract to the second-lowest bidder and that this bidder would have been "sufficiently monitored" and would have performed "a similar amount of work during a given time period."

The audit faults staff for not accurately communicating to the City Council the reasons for the low bid. The report to the council, the audit notes, did not mention that Casey's bid was flawed or explain why the city was awarding the contract to Casey despite the flaws. Furthermore, the audit found that the city had authorized $1.7 million of its $1.9 million to Casey without a "valid, renewed contract." Rather than reissuing the contract every year, as specified in the 2009 agreement with Casey, the city used a less stringent "purchase requisition" procedure that automatically extended the conditions.

In a response to the audit prepared by Perez and Fong on behalf of City Manager James Keene, officials agreed with the auditor's conclusion that renewal "was not done as specified in the contract terms."

"In the future, staff responsible for contract and project management will follow the procedures as outlined in the contract, including a formal evaluation of the contractor's performance, contract compliance, and responsiveness within 12 months at a minimum."

Fong and Perez also agreed that the majority of the contract "was not administered as the contract was originally bid." In the first year of the contract, they wrote, it became apparent that "contract bid items were not matching up with the field conditions as extensive negotiation was required with the contractor on each job to resolve the items not covered in the bid items."

"Based on the uniqueness of the individual jobs, staff decided to use the 'time and material' section of the contract instead of the 'fixed bid' items," Fong and Perez wrote in the response.

They stated that they agree "the contract required more diligent management" and that construction work was not well-documented.

"Staff is developing a new tracking system and implementing new documentation procedures to ensure project documents are compiled, organized and readily accessible for review," Fong and Perez wrote.