4 Common Types of Construction Contracts
A construction contract provides a legal binding agreement, for both the owner and the builder, that the executed job will receive the specific amount of compensation or how the compensation will be distributed. There are several types of construction contracts used in the industry, but there are certain types of construction contracts preferred by construction professionals.
Construction contract types are usually defined by the way, the disbursement is going to be made and details other specific terms, like duration, quality, specifications, and several other items. These major contract types can have many variations and can be customized to meet the specific needs of the product or the project.
Lump Sum or Fixed Price Contract Type
This type of contract involves a total fixed priced for all construction-related activities. Lump sum contracts can include incentives or benefits for early termination, or can also have penalties, called liquidated damages, for a late termination. Lump Sum contracts are preferred when a clear scope and a defined schedule has been reviewed and agreed upon.
This contract shall be used when the risk needs to be transferred to the builder and the owner wants to avoid change orders for unspecified work. However, a contractor must also include some percentage cost associated with carrying that risk. These costs will be hidden in the fixed price. On a lump sum contract, it is harder to get credit back for work not completed, so consider that when analyzing your options.
Cost Plus Contracts
This type of contract involves payment of the actual costs, purchases or other expenses generated directly from the construction activity. Cost Plus contracts must contain specific information about a certain pre-negotiated amount (some percentage of the material and labor cost) covering contractor’s overhead and profit. Costs must be detailed and should be classified as direct or indirect costs. There are multiple variations of Cost Plus contracts and the most common are:
- Cost Plus Fixed Percentage
- Cost Plus Fixed Fee
- Cost Plus with Guaranteed Maximum Price Contract
- Cost Plus with Guaranteed Maximum Price and Bonus Contract
Cost plus contracts are used when the scope has not been clearly defined and it is the owner responsibility to establish some limits on how much the contractor will be billing. When some of the aforementioned options are used, those incentives will serve to protect the owner's interest and avoid being charged for unnecessary changes. Be aware that cost-plus contracts are difficult or harder to track and more supervision will be needed, normally do not put a lot of risk in the contractor.
Time and Material Contracts When Scope is Not Clear
Time and material contracts are usually preferred if the project scope is not clear, or has not been defined. The owner and the contractor must establish an agreed hourly or daily rate, including additional expenses that could arise in the construction process.
The costs must be classified as direct, indirect, markup, and overhead and should be included in the contract. Sometimes the owner might want to establish a cap or specific project duration to the contractor that must be met, in order to have the owner’s risk minimized. These contracts are useful for small scopes or when you can make a realistic guess on how long it will take to complete the scope.
Unit Pricing Contracts
Unit pricing contracts is probably another type of contract commonly used by builders and in federal agencies. Unit prices can also be set during the bidding process as the owner requests specific quantities and pricing for a pre-determined amount of unitized items.
By providing unit prices, the owner can easily verify that he's being charged with un-inflated prices for goods or services being acquired. Unit price can easily be adjusted up and/or down during scope changes, making it easier for the owner and the builder to reach into agreements during change orders.