Category: Construction Contracts
Construction Contract Types
Explained and Compared
The construction contract will be the deciding factor in nearly every dispute that crops up between an owner and contractor – or a general and a subcontractor – which is why it is so vital for contracts to be reviewed by an experienced construction lawyer, to ensure that your rights are as inclusive and favorable as possible.
In this article, I will layout the 5 most common construction contract types that I come across, and answer the following:
- Which construction contract types pair best with which projects
- Which construction contract types provide builders with the most rights
- Which construction contract types create the widest profit margins for builders
Lump-sum contracts (also known as fixed-price contracts) provide a total lump sum, priced for the entirety of the construction project. These are the most basic – and common – types of construction contracts, as they provide a single price for all of the work requested. As a contractor, you’ve likely encountered multiple lump-sum contracts throughout your career.
Lump-sum contracts pair best with smaller projects with clearly defined scopes of work. This is because…
- Lump-sum contracts pair best with projects that are fully designed and approved by the governing planning and building authority, with detailed drawings and specifications already in place. This is because…
- Lump-sum contracts require that builders shoulder a good amount of risk. Namely, lump-sum contracts do not account for delays or unexpected costs once the project begins – you name your price for the whole project, and get paid exactly that amount. Due to this…
- Lump-sum contracts require highly accurate estimates in order to generate significant profit margins for builders. This plays into both sides:
- The more under-budget the project runs, the higher the builder’s margins; you pocket any excess because this contract is set at a fixed price. However…
- Any miscalculations within your estimate eat through your margins; and the larger the project, the more room for error. When dealing with large projects that involve multiple subcontractors and suppliers, the more likely there will be setbacks and mistakes, commonly known in the industry as “bid busts” – mistakes that withdraw straight out of the lump sum contract price.
Cost Plus Contracts
Cost plus contracts (or cost-reimbursement contracts) require that owners pay the contractor for all of the costs associated with the construction project – in addition to a set price for the contractor’s profit. The profit (plus) portion of a cost plus contract is usually determined by a percentage (anywhere from 10% to 25%) of the total price of the construction project.
Cost plus contracts pair best with larger projects that involve ongoing design changes from owners. This is because…
- The majority of risk is placed on the owners. You, as a contractor, are reimbursed for any and all costs incurred during the project – so delays and unexpected changes in the scope of work (design changes, for example) are all automatically included in your reimbursements. This is why owners typically require limits and detailed documentation to prove direct and indirect costs. Due to this…
- Cost plus contracts provide contractors with generous flexibility during estimates, and have the potential to yield significant profit margins for builders – if negotiations are handled correctly.
- Since profit margins are determined at a fixed percentage of the total project cost, contractors can yield higher profit margins with better plus clauses leveraged during the bidding & contract drafting phases.
Time & Materials Contracts
Time and materials contracts establish an hourly or daily rate for the labor and equipment utilized in the project, while providing reimbursement to the contractors for all material costs incurred during the course of the construction project. Unlike cost plus contracts – where owners knowingly enter into riskier terms in exchange for the freedom to alter design plans – time & materials contracts are more useful when the project’s scope of work is still undefined.
Time & materials contracts are beneficial for contractors in nearly every construction project. This is because…
- The majority of risk is placed on the owners. As a contractor, any unforeseen setbacks and additional costs for materials will all be reimbursed according to the contract terms. These contracts are wildly beneficial to contractors given the unpredictable nature of the construction industry. Due to this…
- Time & materials contracts provide contractors with pre-determined, set wages capable of creating significant profit margins; profit margins are set in stone, based on your negotiated wages – and those margins won’t be affected by setbacks, delays, or change orders.
Unit Price Contracts
Unit price contracts provide increased pricing transparency for owners by dividing the contract’s pricing into predetermined units. Under a unit price contract, the contractor provides owners with specified prices for task segments (units) required to complete the construction project. Under these contracts, owners agree to pay contractors for all of the units required to finish the project – regardless of change orders.
Unit price contracts pair best with construction projects that involve repetitive tasks that may not yet have a known or specified quantity of work; unit price contracts are most commonly seen in state or federal road, sewer, boring, or dredging projects. This is because…
- Pricing for the contract is broken into transparent units; if we know that a project requires roads to be built, but we aren’t yet sure exactly how many feet of road (or yards of stone or asphalt overlay) will be required, we are still able to determine a specified price for a single foot or cubic yard of road or stone. This places a large amount of risk onto the owners, as they are required to reimburse the costs of unexpected units that may be added during the construction project’s lifecycle. Due to this…
- Unit price contracts maintain set profit margins for contractors, regardless of the amount of units required to complete a project. If extra work is required, it is simply added on as another pre-priced unit – which already has your profit margins built-in to the pricing.
Guaranteed Maximum Price Contracts
Guaranteed maximum price (GMP) contracts create a cap on the contract price. Under GMP contracts, owners specify that they will not exceed the contract price, regardless of unexpected material or labor costs that may arise. Other contract types may include GMP provisions within them; for example, a cost-plus contract may include a GMP clause that limits the contract’s costs to a guaranteed maximum. In fact, GMP provisions are very common across the construction industry.
GMP contracts are best suited for projects with specified scopes of work and very few unknowns. This is because…
- The majority of risk is placed onto the contractors. Unfortunately, with a set maximum price on the contract, unforseen material costs or setbacks must be shouldered by the contractor. Due to this…
- GMP contracts provide uncertain grounds for estimating profit margins; if you are able to negotiate the maximum price of the contract, this risk can be mitigated. Accurate cost estimating is a necessity to ensure that your profit margins are not affected by incorrect labor or materials costs.
Ultimately, the optimal construction contract for your project is best determined on a case-by-case basis. Often, a contract or subcontract will be a unique blend of several of the above-mentioned contract types. A fixed price contract, for example, will often include at least some unit prices, together with a provision that says if the parties cannot mutually agree on the price of a change order in advance, the change order will be billed at cost plus a specific margin for profit and overhead. By working hand-in-hand with an experienced construction law attorney, you can ensure that every contract you enter into is optimally drafted to mitigate your risks and provide you with favorable clauses geared towards increasing your profit margins – or providing you with enough flexibility to prevent those margins from ever being affected by delays, setbacks, or change orders.
I regularly negotiate, draft, and enforce construction contracts for my clients within the construction industry. There is simply no better way to ensure that your rights are protected – especially your rights to timely payments. For a free, 15-minute consultation regarding your construction contracts, please take a brief moment to fill out the form below!