4 Types of Construction Contracts
There are various kinds of construction contracts used within the industry. The specific type of contract is usually determined depending on how the disbursement will be made. This will vary from project to project. The specific details of the contract will usually include duration, quality, scope of the work, specifications, and penalties for delays. Ultimately, the contract serves as a legally binding agreement between two parties that they will complete the work and be compensated accordingly. In this article, we will review the most common types of construction contracts, including a cost plus contract, lump sum contract, unit price contract type, and time & material contract.
Cost Plus Contracts
In this type of contract, the owner assumes most of the risk. Cost plus contracts designate the buyer to pay the costs of construction, purchases, and other expenses produced from construction activity. There are many variations of cost plus contracts including; cost plus fixed percentage, cost plus fixed fee, cost plus with guaranteed maximum price contract, and cost plus with guaranteed maximum price and bonus contract. These variations can help to protect and lower risk for the owner. This type of contract is most commonly used when the scope hasn’t been clearly defined. It is also important to note that this type of contract will require more supervision and tracking.
Lump Sum/Fixed Price Contracts
In this type of contract, the contractor assumes more of the risk. Lump sum contracts specify a total fixed price that will be paid for all construction work. In this type of agreement, owners agree to pay this fixed price and the contractor agrees to complete the project for this fixed price. The contractor takes on more risk in this situation because there is always a possibility of potential problems and higher prices. In order to protect the contractor, some lump sum contracts contain allowances which designate certain costs to the owner if the contractor goes over budget. Incentives can also be included for contractors if they finish a project early/below budget, as well as penalties if they finish a project late. Fixed price construction contracts are most commonly used when the owner wants to evade dealing with change orders for unspecified work.
Unit Price Contracts
In this type of contract, both parties assume little risk. Unit price contracts involve the contractor determining a specific price for a certain task. After this, the owner must agree to pay that price for the number of units the contractor provides. There are benefits for both the owner and the contractor in a unit price contract. Owners benefit because they can easily verify that they are being charged reasonable rates and contractors benefit because they don’t have to worry about inaccurate estimation for certain tasks. This unit pricing contract is most commonly used on repetitive or public works projects.
Time & Material Contracts
In this type of contract, the owner assumes more of the risk. Time & Material contracts involve the owner paying for the time and materials spent on a project. This usually involves the owner and contractor agreeing upon pay rates and any expenses that might possibly come up over the course of a project. The owner assumes more of a risk in this situation because they are responsible for paying for extra or overtime costs. In order to protect the owner, time & material contracts will usually establish a maximum price clause. This type of contract is most commonly used when the project scope is small or unclear.
Before you agree to a contract make sure that it is protecting both of your interests. Construction contracts entail a great deal of money and risk, so you want to make sure you are choosing the right type of contract. This means doing your research because once you sign your name, there’s no going back! With a little extra effort, you can customize the right construction contract agreement for you and your project.