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What You Need To Know About All Types Of Construction Contracts?

Published by
Rami Tawasha

A Construction project involves many persons, and a basic document is necessary where everyone’s rights and liabilities are defined for the smooth conduct and successful completion of the project. The construction contract is an agreement between the parties involved in the construction project that defines the terms and conditions on which the construction must be completed.

The Construction contract is drafted in such a way that it contains all the

  • General conditions of the construction project
  • Special conditions of the agreement between the parties
  • Details of the construction work
  • Specifications of the project work
  • Time limits for the completion of the project work
  • Payment terms
  • Penalties for late delivery
  • Resolution of disputes

As such, the construction contract is the basic document on which the entire construction work is executed with a clear definition of the rights and obligations of each one of the parties engaged in the construction work. Hence the construction contract is drafted and executed in such a way that it can be enforced in a court of law.

The Construction Contract is an exhaustive and extensive document that covers and deals with every phase of the construction project. It is prepared based on the following construction documents like

  • General conditions
  • Special conditions
  • Drawings and specifications
  • B.O.Q (bill of quantity)
  • Letter of acceptance
  • Contractor bid

There are various types of construction contracts in operation to suit each construction project’s uniqueness that have different ways of achieving the result of the successful completion of the construction work.

 

Selection of Type of Construction Contracts

Every project has its particular circumstances and uniqueness, so it’s crucial to select the contract type which suits the project. The selection of a particular type of construction contract depends on factors like

  • Project objectives to be achieved
  • Project constraints subject to which the project has to be completed
  • method on which the project must be delivered

 

Types of Construction Contracts

In practice, we see that construction contracts come in many types with their own advantages and disadvantages. These are mainly categorized into two major types depending on the method of payment to be made by the project owner to the contractor or the person who is directly involved in the project’s execution.

They are

  • Lump-sum contract
  • Unit price contract
  • Cost-plus contract
  • Target cost contract
  • Price-based Construction Contracts
  • Time and Materials Contracts

 

1. Lump-Sum Construction Contract

In this type of construction contract, the contractor works out the quantum of works involved in the construction project and prepares a detailed bid with a single fixed price to complete the entire project activities.

In this type of construction contract, the contractor takes responsibility for preparing the estimation for the entire project costs based on the project specifications and the project drawings and adds his mark–up as his profit, and submits the same as a single bid to the project owner.

When the project owner accepts the bid, the contractor has to complete the project within the price set in his bid, and the project owner has to make the payment of the agreed bid amount as the project cost to the contractor.

Pros of Lump Sum type of construction contract

  • Simplicity: this contract is straightforward in outlook as the contractor submits single pricing, and the owner accepts the same and agrees to pay it, and the contract proceeds to complete the project based on the accepted price. There are no multiple bids.
  • More profit for more efficiency: when the contractor can complete the project under the budget, he gets more profit
  •  No uncertainties: As all the specs of the construction have been included in the contract, there are no uncertainties, and the project owner is sure of getting what he wants at a fixed price.

Cons of Lump Sum construction contract

  • Not good for the contractor: as there is no flexibility for the contractor’s errors in calculations, and no variables are allowed in the agreed project specifications, there is no scope for revision of the price after commencing the project.
  • Mis-steps and miscalculations will work against the contractor and will eat away his profit.
  • No scope for unexpected setbacks or changes during the execution of the project

 

So, this type of lump-sum payment construction contract may work against the contractor. Especially in large construction contracts, there is more room for suffering loss unless the contractor can have a very high degree of performance without giving room for errors missteps during the project’s execution.

Hence, this construction contract is more suited for smaller to medium types of projects with well-defined and predictable scopes of work.

 

2. Unit Price Construction Contract

This is a type of construction contract in which the contractor gives an item war project cost to the project owner and undertakes the project upon the condition that he will be paid for each unit of the project on its completion. The contractor gives a detailed break-up of the project, takes each item of the work on a fixed unit cost, completes it, and gets paid for that unit of work.

In this type of contract, the project’s risk is shared by both the contractor and the owner, and this offers more flexibility to the contractor as there is a good chance for taking care of the unexpected setbacks and errors in the construction.

Pros of Unit Price Construction Contract

  • Simplified invoicing: as the entire project is broken into smaller units of work with their own pricing, the invoicing of the project is much easier, and this allows more transparent pricing for the project.
  • Fewer chances for disputes: as the entire project proceeds on transparent pricing and the outcome of each one of the individual units are well defined, there is no scope for disputes.
  • No chance of reduction in profit: the contractor works on a per unit basis with payments well defined for each of the units, and hence more work means more profit, so his chance of loss is minimal

Cons of Unit Price pricing contract

  • As the entire project is executed in smaller units, predicting the final value and the result of the project is difficult to predict.
  • As the units that are needed to be completed are known beforehand, it may make the owner pay more than the necessary amount.
  • There may be delays in making payments as each unit becomes a different project and the measurement and outcomes have to be measured and ascertained for each unit.

 

3. Cost-plus Construction Contract

In this type of construction project, the contractor is paid as per the project’s actual cost after including direct and indirect costs incurred by the contractor. He is paid a specific fixed fee or a percentage of the total project cost.

In this type of construction contract, most of the risk resides with the owner, and he has to be actively involved in the management of the project, as the contractor will not be affected by the errors in the work or missteps, and there are no chances of facing loss by the contractor as he is entitled to receive his fixed fee.

 

4. Target Cost Construction Contract

In this type of construction contract, the contractor agrees to complete the project at a target cost, and in return for this, the owner agrees to pay the contractor a fixed or a percentage of the project’s total cost. In this type of contract, the contractor is exposed to risks as he will not get any amount if the project cost exceeds the specified target price.

There is a risk carried by the contractor in case of an increase in construction projects’ cost. The contractor has also rewarded a percentage of any savings between target and actual cost.

 

5. Guaranteed maximum price (GMP) contracts

In this type of construction contract, there is a cap on the project price, and the contractor has to complete the project within this price range; and if he is not able to complete the project within this price, then the contractor has to bear the extra cost to complete the project.

This type of project is good for projects with fewer or no unknowns.

Pros of GMP contracts:

  • Guaranteed price as there is a cap on the maximum amount the owner is willing to pay for the contract
  • Shorter bidding time as the process of the project and pricing are well known.
  • Incentivize the savings in the execution of the project, and hence there is a higher performance level.

Cons of GMP contracts

  • Riskier for the contractors as there is no flexibility to compensate for overages
  • Requires more time to review and negotiate

 

6. Time and Materials Contracts

This type of construction contract is used in the case where the scope of the project cannot be defined easily. In this contract, the contractors are reimbursed for the cost of the materials used by them along with payment for the labor based on an hourly or daily rate.

Pros of T&M

  • It covers the uncertainties as there is payment for the materials and labor used in the project.
  • Simple and faster negotiations as the type of materials to be used alone are to be discussed and finalized.

Cons of T&M

  • Time-consuming process: tracking of time worked, and materials used is a time consuming and long process
  • Prone to disputes: as the payment is based on the use of material and labor, which is hard to track with accuracy chance for disputes is there
  • No reward for performance: as this type of contract does not provide for any extra payment for early completion, and there is an incentive for high performance or early completion of the project.
  • The considerable risk for the owner as he undertakes all the uncertainties connected with the project

Thus there are many types of construction contracts, and you have to carefully choose the one that is capable of assuring the best results to you at the best possible pricing. Though uncertainties may crop into the project during the execution phase, these can be easily taken care of when your construction contract is wide enough to accommodate and provide for them without tipping you off the ground.

 

This post was last modified on March 3, 2021 2:34 am

Rami Tawasha

An experienced civil engineer with more than 15 years of experience, Rami Tawasha serves as a senior project manager for Constructive Solutions, Inc., a commercial general contractor based in San Mateo and San Francisco. Under his leadership, the firm performs services ranging from design build to tenant improvement and renovation for corporate offices, medical facilities, building renovation, seismic retrofit, industrial and retail spaces across the San Francisco Bay Area.

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Rami Tawasha

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