Construction contracts set expectations for a project and protect everyone involved. The contracts can be structured to meet the specific needs of a project, and since the details and expectations of each project can vary greatly, it’s good to know the different types of construction contracts you might encounter.
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The importance of contracts in construction
A contract is an agreement on all of the details included in a construction project, including project scope, timeline, and budget. Construction contracts also typically include information about liability and responsibility should portions of the agreement not be met according to the terms of the contract, whether that means the project was not completed on time or on budget. A contract helps to set expectations with your client on the project cost and schedule, and keeps everyone on the same page. By putting all of these details into signed documents, you can have a common reference document for the project, which helps foster better transparency and communication among all parties involved.
What’s included in a basic construction contract?
A construction contract should include the following information.
- Budget. The project owner needs to understand how much the construction process will cost. The budget typically details the cost of materials and labor for the project. Depending on the type of contract, there could also be a separate profit margin included for the contractor.
- Timeline. The contract should outline the projected timeline. Larger projects may have the timeline broken down into specific milestones, while smaller projects may just include an expected completion date.
- Scope of work. This section outlines the tasks and deliverables associated with the project. The scope of work defines what a contractor is expected to do in order to close out the project.
- Risk/liability. It’s important to define the risk and liability to both parties, particularly in terms of what happens when there’s a budget overage. Who pays for the difference? Are there any other consequences for going over budget or timeline?
6 Types of construction contracts
There are several types of contracts to choose from when creating a bid on a project. Learn about each one so you can use the best options for the specific types of projects you’re involved in.
Lump sum contract
A lump sum contract, also called a fixed price contract, is quite common in the construction industry. Just as the name implies, the contract documents outline the work to be done for a single fixed fee, rather than incorporating variables into the project costing. This type of contract works well for smaller projects that aren’t likely to have a lot of variance in the scope or materials cost.
Pros of a lump sum contract:
- There is a potential for higher margins if the project comes in under budget.
- Provides a clear outline of the project scope and deliverables.
Cons of a lump sum contract:
- Risk is assumed by the contractor, who typically absorbs any project overages.
- Plans may need to change in order for the project to stay on budget.
A design-build contract requires a collaboration between the project designer (the architect or engineer) and the builder. Rather than having the project owner solicit separate bids for the design and construction processes, both phases are rolled into one contract. This saves the owner time (and potentially money) since they don’t have to wait for the design process to be complete before moving forward.
Pros of a design-build contract:
- Facilitates a faster bid process for clients.
- Allows for a streamlined project timeline since the designer and builder work together throughout the process.
Cons of a design-build contract:
- The project owner may receive fewer bids, making the negotiations potentially less competitive.
- The client may incur higher costs since all work for a project is rolled into one contract.
A cost-plus contract includes two elements of payment for the contractor: the cost of the materials and labor, plus a separate fee as the contractor’s profit. The fee can either be pre-determined as a set figure, or it could be a percentage of the final project costs.
In addition to covering the project expenses, a cost-plus contract can also include overhead expenses. This could include things like travel fees and a portion of the contractor’s office and administrative expenses. Cost-plus contracts are best suited for projects with an ambiguous scope or with many changing variables. Most cost-plus contracts do include a “not to exceed” limit, which does set some budgetary boundaries.
Pros of a cost-plus contract:
- Low risk of the contractor losing money on a project.
- Allows for ongoing changes to the project.
Cons of a cost-plus contract:
- The contractor must carefully track expenses and may need to justify them to the client.
- The contractor may need upfront capital to pay for project materials.
Guaranteed maximum price contract
A guaranteed maximum price contract (GMP contract) puts a limit on the final budget of a project. Any overages are covered by the contractor, whether in the form of labor or materials. A GMP contract can be a standalone contract, or a different type of contract may simply incorporate a guaranteed maximum price along with other specific terms.
The goal is to make the budgeting process easier for the project owner, but it does shift some financial risk to the contractor. On the plus side, a contractor may include a clause to share any project savings with the client, offering a win-win for both parties when a project is finished on time and under budget.
Pros of a GMP contract:
- Simpler, faster negotiation process.
- The contractor may be able to share savings when the project comes in under budget.
Cons of a GMP contract:
- The contractor is responsible for any project overages that occur.
- Initial contract bids may need to be higher in order to build in financial protection.
Unit price contract
A unit price contract divides the contract into separate elements, such as materials, labor, and overhead or administrative costs. This helps to increase transparency in the contract for the owner. Each section of the contract includes a unique estimate so that both the builder and the owner know what to expect. This is especially useful if a specific component is driving up the project cost, such as a special material required for the project.
Unit price contracts are better suited for small projects and can typically be adjusted if part of the scope changes. It’s easy to identify what costs need to be altered to adjust for the new project scope.
Pros of a unit price contract:
- Clear budgets with easier invoicing helps to decrease the opportunity for disputes.
- Risk is shared between the owner and the contractor.
Cons of a unit price contract:
- Not suited for complicated projects with many different elements and materials.
- There’s not always a firm budget to give to the client at the beginning of the project.
Time and materials contract
A time and materials contract takes a holistic approach to the project, with set prices for the amount of time a project takes, the cost of materials, and the contractor’s profit margin. It’s similar to a lump sum contract but gives the contractor room to separate materials from labor rates.
In a time and materials contract, the contractor sets an hourly or daily rate, making it a good option for projects without a clear scope or timeline. And if materials are bought at a wholesale price, the contractor can usually include some markup to account for the professional discount.
Pros of a time and materials contract:
- Limits risk for the contractor since they have a set rate based on the length of time the project takes.
- Shifts the focus on quality rather than cutting corners.
Cons of a time and materials contract:
- Could be difficult for the client to budget costs.
- Project timeline and costs could be subject to scope creep and could benefit from price caps.
MT Copeland offers video-based online classes that give you a foundation in construction fundamentals with real-world applications, like how to read construction contracts. Classes include professionally produced videos taught by practicing craftspeople, and supplementary downloads like quizzes, blueprints, and other materials to help you master the skills.