Three Common Construction Contracts
By Garret Murai
Like Baskin Robins, construction contracts come in a variety of different flavors although, thankfully, significantly fewer than 31. Here are three of the more common types of construction contracts between project owners and contractors:
Fixed price construction contracts, also commonly referred to as “lump sum” or “stipulated sum” contracts, are the most common types of construction contracts. As its name suggests, under a fixed price contract a contractor agrees to construct a project for a “fixed” or agreed upon price.
Benefits: These provide price predictability for project owners because absent changes in the scope of work, unforeseen conditions, or other circumstances that cause the project to change, the contractor must complete the work for the agreed upon price.
Drawbacks: These can be more expensive for project owners than other types of construction contracts because contractors, knowing that they are going to be subject to a “fixed” price, will often build in a buffer to protect itself from cost overruns, for which the contractor would not be compensated. They can add to the time and cost of the design phase of a project, which can affect the overall project timeframe They also can result in lower quality work because contractors may adopt a “cheaper is better” approach knowing that any cost savings they can achieve will improve their profit margin.
Best Use: Projects with well-defined scopes of works, where the project owner wants price certainty.
Under a cost plus construction contract, also known as a time and materials contract, a project owner agrees to pay a contractor for its costs plus a fee, which may either be a fixed fee or calculated as a percentage of costs.
Benefits: These offer the most design flexibility for project owners and best price predictability for contractors since owners can make design decisions along the way, and contractors know they will be paid for their time and cost of materials, no matter how long the project takes or the quality of materials used.
Drawbacks: Because time and materials are variable, these contracts provide owners with the least control over costs. Because of the cost uncertainty,, it can be difficult for owners to obtain construction financing. Finally, it can be difficult for contractors to schedule their work on the project and juggle workforce and other resources.
Best Use: Smaller projects or specific scopes of work within larger construction projects where more flexibility is needed.
GUARANTEED MAXIMUM PRICE
Under a guaranteed maximum price contract, project owners agree to pay contractors for their time and cost of materials plus a fee—but only up to a “guaranteed maximum price.”
Benefits: Under this approach, contractors get a degree of price predictability because they will be paid for their time and materials and project owners retain more design flexibility. Similar to a fixed price contract, project costs are capped at a “guaranteed maximum price.” These contracts can include a shared savings provision whereby the parties agree to split any savings if the actual costs of construction are less than the guaranteed maximum price.
Drawbacks: Contractors under a guaranteed maximum price contract often build in a buffer to protect from cost overruns that cause the contractor to exceed the guaranteed maximum price. If there is a shared savings provision, a contractor may try to increase the guaranteed maximum price in order to benefit from “more” shared savings. These contracts can take more time to negotiate and administer.
Best Use: Best for sophisticated project owners and contractors.