The construction contract forms the legal basis for all transactions in the construction industry. That is why it is of utmost importance that you give careful consideration to how you construct your contract—ensuring the format is one that best serves the size and scope of your project.
Among these common formats is guaranteed maximum price contracts, or GMP.
What is a GMP contract?
In a guaranteed maximum price contract arrangement, the contractor is compensated for materials, labor, and a contractor’s fee. But the contract is subject to a guaranteed maximum price, which is the highest amount a property owner is willing to pay for the project overall. Costs that exceed the maximum are borne by whoever is performing the work.
A typical GMP contract will generally base its maximum on four variables:
- A detailing of the project’s tasks.
- Direct costs of the project.
- Indirect overhead costs incurred by a contractor.
- Any profit specifications a contractor hopes to make.
For example, a GMP with a general contractor to build a barn would include the project’s direct cost of the works of $100,000; plus overhead costs of $15,000; and a fee including the contractor’s desired profit of $25,000—a maximum of $140,000.
GMP contracts are most suitable for projects with costs that can be accurately assessed at the outset and aren’t generally subject to major price fluctuations.
GMP vs. fixed-price contracts
A GMP contract differs from a fixed-price contract, such as a lump sum contract, in that, for the latter, the price remains the same no matter how much a contractor spends to complete the project. GMP contracts are more flexible—the property owner will reimburse the contractor for expenses up to the maximum. In both contract arrangements, contractors are responsible for cost overruns.
The construction contract forms the legal basis for all transactions in the construction industry. That is why it is of utmost importance that you give careful consideration to how you construct your contract—ensuring the format is one that best serves the size and scope of your project.
Among these common formats is guaranteed maximum price contracts, or GMP.
What is a GMP contract?
In a guaranteed maximum price contract arrangement, the contractor is compensated for materials, labor, and a contractor’s fee. But the contract is subject to a guaranteed maximum price, which is the highest amount a property owner is willing to pay for the project overall. Costs that exceed the maximum are borne by whoever is performing the work.
A typical GMP contract will generally base its maximum on four variables:
- A detailing of the project’s tasks.
- Direct costs of the project.
- Indirect overhead costs incurred by a contractor.
- Any profit specifications a contractor hopes to make.
For example, a GMP with a general contractor to build a barn would include the project’s direct cost of the works of $100,000; plus overhead costs of $15,000; and a fee including the contractor’s desired profit of $25,000—a maximum of $140,000.
GMP contracts are most suitable for projects with costs that can be accurately assessed at the outset and aren’t generally subject to major price fluctuations.
GMP vs. fixed-price contracts
A GMP contract differs from a fixed-price contract, such as a lump sum contract, in that, for the latter, the price remains the same no matter how much a contractor spends to complete the project. GMP contracts are more flexible—the property owner will reimburse the contractor for expenses up to the maximum. In both contract arrangements, contractors are responsible for cost overruns.
Changes to GMP contracts
There are certain mechanisms that can be built into a GMP contract to ensure contractors aren’t necessarily hung out to dry when a maximum is exceeded, or lessen the likelihood of overages generally.
- Contingency amounts. This is how parties to a GMP plan for unknowns. Contingency amounts are a property owner’s reserve, or an amount designated to address possible additions or changes to the property. These can be built into the anticipated price of the contract, increasing the maximum away from a simple estimation of direct and indirect costs. This gives contractors more breathing room.
- Allowances. Allowances are similar to contingencies in that they also allow parties to a GMP contract to plan for unforeseen costs. They are amounts designated for decisions the property owner has not yet made regarding specific aspects of the project, usually concerning materials.
- Change orders. Change orders are mutual agreements to amend the GMP contract, usually to increase the maximum price or extend the timeline due to unforeseen issues or material changes to scopes of work. A good GMP contract will establish a procedure for requesting and approving change orders.
Advantages and disadvantages of GMP contracts
There are a number of advantages and disadvantages to utilizing a GMP contract to govern construction projects.
Advantages
- Quick turnaround. Because the total contract price is set early on in the project timeline, the bidding process is often accelerated. Financing can also be sourced easier and more quickly, as lenders don’t like to deal in uncertainty.
- Savings. Since the party performing the work bears most of the risk in a GMP arrangement, the contract imposes incentive on contractors and subcontractors to keep costs down and complete work on time. They don’t want to be stuck covering overages themselves.
Disadvantages
- Contractor risk. As mentioned, parties performing the work under a GMP contract bear most of the risk. Contractors know the cost maximum at the outset of a project. If they go over, it’s their responsibility to cover the excess cost.
- Threat of fraud. Unethical contractors may try to submit proposals that justify an inflated GMP, then utilize low-skill labor and low-quality materials to increase savings on their end. In this scenario, the property owner isn’t getting their money’s worth.
Final thoughts
If a property owner wishes to be an active participant in the design and construction of a project, GMP contracts may be preferable to flat fee-based contracts. An involved owner will exercise the necessary accounting oversight to ensure maximums are being enforced and contractors are being transparent about any cost savings on their end.
MT Copeland offers video-based online classes that give you a foundation in construction fundamentals with real-world applications, like how to prepare a construction estimate. Classes include professionally produced videos taught by practicing craftspeople, and supplementary downloads like quizzes, blueprints, and other materials to help you master the skills.
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DR. KENNETH SANDS
Dr. Kenneth S. Sands II is an Assistant Professor in the Construction Management Program at Florida Gulf Coast University in Fort Myers, FL, and an experienced construction management professional. He holds a doctorate in Environmental Design and Planning from Virginia Tech in Blacksburg, VA. He’s also worked as an estimator and project manager, with previous experience in purchasing, buyout and project site supervision. Dr. Sands’s passion for the construction industry was inspired by his father’s work as a carpenter.
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