Guide to Construction Contracts
Along with the excitement and anticipation surrounding the design and construction of a new
addition, building or a campus, every project begins with a construction contract.
There are several types of contracts available, each with its pros and cons, so it’s important to evaluate which approach is going to work best for the project at hand.
Factors to consider include the project’s scope, schedule, including the time you have to get the
project started, budget and the parties involved. These variables and the selected contract will significantly impact the project’s delivery and often profit margins.
The following is an overview of the five most common contracts used in the commercial construction industry today.
Cost-Plus Contract
With this type of contract, all construction-related expenses are covered by the owner. This includes labor, materials, supplies, etc. In addition, overhead costs like insurance, gas mileage, construction trailers, etc., are accounted for as well.
Expenses are reported as they occur and contractors run a low risk of losing money in materials.
This type of arrangement is well suited for projects where the scope is not well defined and/or it’s difficult to provide a thorough estimate of the work. Also, if there is not ample time to move forward with other types of projects. That said, it will fall on the contractor to track expenses and submit them for reimbursement.
The cost-plus contract can also include incentives for coming in under budget and set caps on expenditures. Consequently, both owners and contractors are motivated to manage the project costs.
Design-Build
With design-build, a project’s design and construction is combined into one contract. With this project delivery approach, construction may commence before the design is completed. This fast tracks the construction and supports greater collaboration between the design and construction teams.
At the same time, it can be more challenging to estimate costs, plus the fact that there’s no competitive bidding in certain areas beyond the project’s onset. That said, the highly collaborative aspect of design-build construction and the expedited speed to market often more than compensates for this.
Guaranteed Maximum Price
With a guaranteed maximum price (GMP) contract, the maximum amount the owner will have to pay the contractor is capped. Consequently, the building owner’s risks are lowered as the general contractor takes acts as the construction manager at risk (CMAR).
The contract includes costs for labor, materials, overhead and a percentage of those costs to generate a profit. This structure makes budgeting easier and can help expedite the lending process. Project plans are often finalized before construction, so change orders are minimized.
GMP requires careful review and analysis of expenses, which can be particularly time-consuming for large, multi-phase projects. In many cases, a shared savings clause is introduced, which allows any leftover funds to be spent by the contractor should the scope be missed during contract buyout. Further, the contractor must carefully price the project or risk paying out of pocket.
Lump-Sum
In the lump-sum contract, a total price is named for the entire job. This comprises all the time and materials, regardless of any changes or setbacks. Because the contractor is taking on a lot of risk, the cost is often set a little higher. This can be done on GMP and others as well.
This approach works well for projects with a well-defined scope.
Administration and cash flow estimates are easier and the contractor is freed up to focus on quality, materials and output.
For this type of contract to really pay off, contractors need to do a good job of estimating the project’s schedule, materials, labor costs, overhead costs and profit margins.
Integrated Project Delivery
With large, complex projects, integrated project delivery (IPD) can be a good choice. Like design-build, both the design and contract is included in one contract.
The owner, designer and building are motivated to work closely together, often applying lean principles, as they share risk. A lump sum profit is then divided amongst the owner, designer and builder in a financially successful project.
On the downside, IPD contracts are relatively new in the industry and some contractors might find it challenging to secure funding.
About the author
Barbara Horwitz-Bennett is a seasoned architectural journalist, covering the design and construction industry for the past 25+ years. She writes for numerous industry magazines and creates content for AEC firms, product manufacturers and industry associations.
