Nearly every aspect of a construction project is laid out in a series of contracts. Construction contracts are legally binding and enforceable agreements reached between the party performing the construction work (the builder) and the party paying for the work (the owner). These contracts set forth the specific terms and conditions of the construction projects, including details of the scope of the construction work, specifications, payment of costs and fees, timelines for completion, and penalties for delay. There are many different varieties of construction contracts, and this article takes a closer look at a few of the most common types of construction contracts.
Types of Construction Contracts
The best type of contract for a particular construction project will depend on a variety of factors, including the type of building project and the goals of each party.
Lump Sum or Fixed Price
In a “lump sum” or “fixed price” contract, a single lump sum price for all work is agreed to by the owner and buyer before construction begins. Lump sum contracts can include incentives for early completion of a project and liquidated damages or penalties for late completion. With these sorts of contracts, it’s important for the builder to accurately estimate the project costs and overhead before entering into the agreement.
There are both benefits and risks with lump sum contracts. If the builder can keep costs low, they can keep the difference, resulting in a higher profit margin. This also comes with risks; if the builder underestimates costs, the profit margin shrinks or even disappears.
Lump sum contracts are ideal when a clear scope and defined schedule for construction are agreed to at the design phase, because there will be limited flexibility in modifying a design once construction begins. There are some drawbacks for owners, such as less transparency regarding a breakdown of costs and the builder's profit margin.
Cost Plus a Fee
“Cost plus a fee” construction contracts are usually known simply as "cost-plus" contracts. Under this type of contract, owners agree to pay the costs, purchases, and other expenses incurred by the builder, plus a builder's fee to allow for profit.
For this sort of construction contract to be effective, there must be clear definition of what qualifies as a "cost," for example, fees for the outside rental of a crane or hoist. The contract should also set forth the specific structure of the fee, whether it is a percentage of the cost of the work or a fixed fee independent of cost.
One benefit is that a cost-plus contract offers more transparency than a lump sum contract. However, cost-plus contracts will involve more accounting and reporting than a lump sum contract, and will often require an audit to confirm that the amount of the fee is accurate.
A “unit price” contract is based on estimated quantities of items included in the project. The total construction price will depend on the quantity of units needed to complete the project. A good example of a unit price contract is an agreement for building a road. The owner will pay a set unit price for each mile of the road built. In unit price contracts, it’s important that the parties have an accurate count of the number of units of work necessary before agreeing to a unit price.
Due to their nature, unit price contracts are most commonly used with public infrastructure projects, like roads and runways. They are seen less frequently with private building projects, unless used for a select category of costs like door handles, faucets, or other fixtures.
Integrated Project Delivery/Alliance
“Integrated project delivery” contracts, also called "alliance" contracts, represent the latest trend towards a more collaborative approach to construction projects. Alliance contracts involve the participation of owners, builders, designers, architects, and other key stakeholders as early as the conceptual stage of planning. The participants have a peer relationship, and all have an equal say in project decisions. This results in more transparency between the parties and equally shared risks and rewards.
Written alliance contracts set forth the main elements of the integrated project delivery model: the parties' intention to work together as a team, cooperative decision making, risk sharing, lack of blame and dispute, and financial transparency.
Legal Help with Construction Contracts
The best type of construction contract will depend heavily on the project and individual circumstances. It is smart to employ the counsel of an experienced lawyer when negotiating construction contracts. If you need legal help with a construction contract, speak with a local construction attorney today.