When it comes to the construction industry, contracts serve as the foundation of every project, providing clarity and protection for both parties involved. Whether you’re a homeowner looking to renovate your space or a contractor bidding on a large-scale development, understanding the different types of construction contracts is essential.
Cost-Plus Contracts
A cost-plus contract, also known as a cost-reimbursement contract, or time and materials contract, involves the contractor being reimbursed for all project expenses, including labor, materials, and overhead costs, plus a predetermined fee for profit. This type of contract is commonly used when the scope of work is uncertain or when the project needs to start quickly. While cost-plus contracts provide flexibility, they also carry the risk of the total project cost exceeding expectations, making them potentially more expensive for the owner.
Generally we do not recommend cost-plus contracts to owners. They favor the contractor to a great degree, and they result in perverse incentives. The contractor is incentivized to make more money by spending more time (labour) to do the job, resulting in a higher cost and longer timeline to the owner. The contractor is also incentivized not only not to make efforts to find good deals on materials, but to purchase the highest cost materials for the owner (since they make more profit in doing so). With a cost plus contract, the contractor also has less of an incentive to accurately predict construction costs and timelines. Oftentimes, we hear the contractor with a cost plus contract say that their view of the contract is that if they build it, the owner has to pay for it. Even though this is not legally correct, and the owner would likely be able to sue the contractor in this scenario, it puts the owner in the disadvantageous position of being in a dispute with the contractor.
Admittedly however there are some scenarios where fixed price contracts are not possible, or at least not likely to be accepted by contractors. This happens where the scope of work is impossible to determine from the outset. This can often happen where the work is investigative in nature. For example, a contractor cannot make a bid to repair a water damaged house without first investigating the extent of the damage. A cost-plus contract may be unavoidable in this case, at least for the investigation work.
However the remedy to this issue is to pay a small amount to the contractor on a cost-plus basis to do the investigation work, and then once the extent of the damage is known, a fixed price can be provided for the repair. This is, in fact, how most insurers pay for loss-related repair or reconstruction work.
Lump Sum Contracts
A lump sum contract, also referred to as a stipulated sum contract, or fixed-price contract, is perhaps the most straightforward type of construction agreement. Under a lump sum contract, the contractor agrees to provide specified services for a fixed price. This means that the contractor bears the risk of any cost overruns or unforeseen contingencies. Lump sum contracts are ideal when the scope and schedule of the project are well-defined, providing owners with budget predictability.
Fixed-price contracts are also the most commonly employed contracts in the construction industry, especially for larger projects. They have a great number of advantages for both the Owner and the Contractor: they result in certainty with respect to the project cost, and usually also the project scope. Most contractors will spend far more effort in putting together a price for a fixed-price job than they would a cost-plus job. This benefits the contractor just as much as the owner in that the contractor will have a clear idea from the beginning of the job as to how long it will take, what resources he needs, whether he can meet the schedule, and so on.
We strongly recommend parties enter into fixed price contracts in almost all situations.
Guaranteed Maximum Price (GMP) Contracts
Guaranteed maximum price contracts are a hybrid of cost-plus contracts and fixed price contracts.
In a guaranteed maximum price contract, the contractor agrees to deliver the project for a fixed price, known as the maximum price, which includes the cost of construction plus a fee for overhead and profit. However, if the actual costs exceed the agreed-upon maximum price, the contractor is responsible for covering the additional expenses. GMP contracts offer owners budget certainty while incentivizing contractors to control costs and manage the project efficiently.
Unit Price Contracts
Unit price contracts break down the work into various components, with pricing based on anticipated quantities of items and their unit prices. This type of contract is commonly used for subcontractor agreements or maintenance and repair work, where the quantities of items may vary, but the prices for the items do not. Unit price contracts provide flexibility in pricing and are advantageous when the exact scope of work is uncertain but the types of work required are well-defined. These contracts are often employed in the areas of, for example, road building, where the contract would specify so many linear feet of road, or road services, at a certain price. These contracts are another form of fixed price contract that we would recommend in certain circumstances.
Understanding the different types of construction contracts is crucial for both contractors and project owners. Each type of contract offers its own set of advantages and disadvantages, and selecting the right contract type depends on factors such as the scope of work, project timeline, and level of risk tolerance. By familiarizing yourself with these common construction contracts, you can make informed decisions and ensure the success of your construction project. If you have any questions or need assistance navigating construction contracts, don’t hesitate to reach out to the construction law experts at ATAC LAW. Contact us today to learn how we can help protect your interests and ensure a smooth construction process.
