Before breaking ground on a new project, it is crucial to sign the appropriate construction contract. The success, efficiency, and cost-effectiveness of any project depend on your decision. This article will examine three common types of construction contracts, including their key characteristics, advantages, and disadvantages.
There are many different kinds of construction jobs, and each one has its own special requirements for the contract. Construction contracts require detailed descriptions of the project’s scope, schedule, cost, and quality. There are a number of variations in construction contracts, the most salient of which are the payout method and the distribution of risks and rewards among the parties.
1. Lump Sum Contract (Non Re-Measurable)
Commonly used for building projects is the lump sum contract, sometimes known as a fixed-price contract. For a set price, the contractor agrees to see the project through from start to finish. This sort of contract is most appropriate when the scope of work is well-defined and the project’s requirements are crystal clear from the start.
A lump sum contract, often known as a fixed price contract, specifies payment in one installment. This total includes everything, from labor to supplies, no matter what happens. This form of contract may appear to benefit the owner, but contractors typically add a premium to cover the increased risk they take on. Owners may also institute bonus plans for projects that are finished ahead of schedule.
The construction project’s whole price is spelled out in a lump sum contract, and the contractor is bound to finish the job for that price. This contract sum is significantly related to a clearly defined set of deliverables, protecting contractors from being forced to take on unanticipated additional work.
Advantages of Lump Sum Contracts
- Cost Certainty: The main benefit is that expenses will be known in advance. Clients are afforded budgetary stability thanks to the mutually agreed-upon, set fee between the parties.
- Risk Allocation: In a lump sum contract, the majority of the risk rests on the contractor. Any unforeseen expenses or challenges that arise during the project become the responsibility of the contractor rather than the client.
Drawbacks of Lump Sum Contracts
- Limited Flexibility: It can be difficult and expensive to implement scope changes in a project. In the context of a lump sum payment, contractors may be less flexible.
2. Measure & Value / Re-Measurable Contract: Balancing Flexibility and Transparency
The Measure and Value Contract, also known as a Re-Measurable Contract, is an innovative method for drafting contracts in the building industry. Specifically designed for projects with changing scopes of work, it solves the problem of guessing the right amount of resources like time and money at the outset. Unlike fixed-price contracts, Re-Measurable Contracts change the project’s final cost based on the actual quantity of work completed.
- The Measure and Value Contract allows for the scope of work to be modified as needed over the course of the project. Work well with projects that have a high probability of having changes.
- the total price is calculated based on the actual number of hours put in throughout the project. as opposed to predetermined costs established before work began on the project.
- Payment Models – Re-measurable contracts can employ either a cost-reimbursement payment model or a unit-pricing arrangement. When the contractor meets predetermined goals or finishes specified tasks, payment is provided.
- Adaptability throughout the Life Cycle of the Project – Changes in the scope of the project can be included, allowing for a fluid and dynamic process.
- Transparency is enhanced by detailed measurement and assessment of work, which leads to greater trust during the construction process.
- Uncertain Final Costs:
The total cost in a Measure and Value Contract is not fixed, unlike in a lump sum contract. Because of this unpredictability, creating a client budget becomes more difficult.
the Measure and Value Contract strikes a balance between flexibility and transparency, offering a tailored approach for projects with changing scopes of work. While providing adaptability, it is essential to acknowledge the challenge of uncertain final costs in this contract type.
3. Cost Reimbursement / Cost Plus / Prime Cost Contract
When the customer agrees to compensate the contractor for the actual costs spent during construction, a cost-reimbursement contract, also known as a cost-plus or prime cost contract, is the ensuing payment arrangement. The contractor may also be paid a fee or a percentage of the overall cost in addition to being reimbursed.
In a cost-plus contract, the contractor is compensated for all expenses incurred throughout the course of the project, plus a profit that is either a fixed amount or a percentage of the total costs. Instead of a set price, the contractor gives the owner an estimate to give them an idea of what the project might cost all in all. An owner may ask a contractor to set a cost limit on a project in certain circumstances. The contractor must provide detailed accounting for every dollar spent on the project. In order to account for overhead and unanticipated costs, the contractor may build a cushion into certain costs, most notably labor wages. The “plus” factor can be anything from 10 to 20 percent of the entire project budget, although this is not a hard and fast rule.
A cost-plus contract includes two parts: a fixed charge and the sum of all expenses incurred up to that point. Owners will pay contractors the agreed-upon fee, which can be a flat rate, a share of the entire budget, or some other arrangement. Rather than deducting costs from a fixed budget, cost-plus contracts require real-time reporting of spending.
When the final cost of a construction project is hard to predict, these contracts are used. Despite the appearance of this danger, cost-plus contracts typically include incentives for operating under budget and set expenditure ceilings, which help to reduce disagreements and guarantee contractors receive their fair share of the pie.
- Transparency in Costs: Clients gain full visibility into project costs, directly reimbursing contractors for expenses, fostering a robust client-contractor relationship.
- Flexibility: There is a lot of wiggle room in case the project’s scope shifts; no lengthy negotiations are necessary.
- Risk for the Client: In cost reimbursement contracts, the client takes on more of the financial risk for any unanticipated expenses that may arise. Putting a limit on what can be reimbursed is one way to reduce this danger.
4. Time and Materials Contract
When the total scope of a project is completely unknown, time and materials contracts are the best option. In this setup, contractors charge by the hour for their time as well as the products they use. These contracts require detail and contingency planning in light of the inherent ambiguity. Projects that are finished early and/or under budget should be rewarded by the owners.
Time and materials contracts are useful for moderately sized projects that need close oversight. In order to verify and guarantee contract compliance, all expenses must be tracked and categorized with great care. This gets more difficult as the scope of the project expands. Owners are protected from overpaying contractors in a time and materials contract’s primary benefit.
5. Unit Pricing Contract
When a business wants to buy a lot of a certain product, it may use a contract based on per-unit pricing. Each unit carries a predetermined cost, and often, these products can be acquired in big amounts at a discounted rate.
When a buyer needs a specific number of units of a product, this kind of contract is useful. To hedge against any future inflation in material prices, it is prudent to choose for a unit pricing contract and to purchase all units at once. In most cases, owners can save money and avoid future contracts by purchasing all they need at once.
6. Design-Build Contract
A design-build contract is an alternative to the traditional construction bidding procedure in which the project owner receives the final plans before construction begins. Unlike conventional approaches, here both the design and construction phases run concurrently while being overseen by a single contract.
The design and building phases of this project will be accelerated because to the improved coordination made possible by this construction contract. The design-build approach offers a more collaborative and efficient framework for finishing projects.
7. Guaranteed Maximum Price (GMP) Contract
A Guaranteed Maximum Price (GMP) contract is a legally binding agreement between a contractor and a project owner that imposes an upper limit on the total cost of the construction project. Essentially, the contractor undertakes to complete the project without charging beyond the set maximum fee outlined in the contract. The contractor is responsible for covering any expenses that go over the GMP, which could cut into their earnings from the project.
GMP contracts require projects to have a clearly defined scope of work that includes detailed drawings, specifications, and information unique to the site. Without a detailed list of tasks, contractors run the risk of incurring extra fees, cutting into the project’s profit margin.
To protect themselves from overspending, owners might set a hard cap on their building costs in the GMP contract. In the event that final costs exceed the maximum amount guaranteed, the general contractor is responsible for paying the difference.
The best way for general contractors to reduce construction risks is to produce precise cost estimates. This may sound difficult, but it can be made much easier by using construction estimating software like Project Manager or by hiring a professional construction estimator.
Choosing the Right Contract for Your Project
Considerations such as project complexity, scope, and desired degree of flexibility should all be taken into account when deciding on the best construction contract to use. In order to make a well-informed choice, it is essential to have a complete grasp of the benefits and downsides of each contract type.
Choose the right contract for your construction project, whether you like the assurance of a lump sum, the flexibility of a measure and value, or the openness of a cost reimbursement agreement.